My phone’s ringing off the hook. My inbox is flooded. Some people want to know if this market rout is the big one. Others want to cheer us on for sticking to our guns for so long. But everyone has a question: How long will this selloff last?
The answer depends on why equities dropped in the first place. The problem is, there’s no single reason.
Did China kill the markets, or was it oil? Maybe it was the strong dollar. Perhaps, as Krugman claims, governments just don’t have enough debt outstanding (he really said that).
All of those claims – except Krugman’s – are true, and yet none of them are the issue.
Investors are finally waking up to the fact that we are in an economic winter. With it comes a whole assortment of problems: sluggish demand, falling commodity prices, and a race to devalue currencies to boost exports at the expense of everyone else.
Since there is no single issue to blame for the selloff, there’s no individual cure. And that’s the dilemma.
China’s Desperate Measures
China is taking new measures to stop the free fall in both its economy and stock market. Chances are, they won’t work.
The People’s Bank of China might cut the reserve rate requirement for banks. If it does this, then theoretically billions of yuan would suddenly be available for lending. This would help their economy, but only if people want to borrow, which doesn’t appear to be the case.
Then there’s the Chinese stock market. On Sunday, the Chinese government announced that the state pension fund can now allocate up to one-third of its assets to equities.
This approach has a problem similar to cutting the reserve rate requirement. It might prop up stock prices for a while, but it does exactly zero to increase economic demand.
The recent devaluation of the yuan was meant to cut the price of Chinese goods on the world markets – i.e. increase demand from other countries. Now Americans, Australians, Europeans, etc. can buy more of what China sells.
At the same time, the Chinese have to pay more for what all of us sell. This development is a problem for every nation that isn’t China, and still doesn’t address the issue.
The Problem Is Demand
When it comes to selling goods across borders, the problem isn’t exchange rates, it’s demand. American, Japanese, and European consumers control a lot of the world’s capital, but they are aging. They’re not the consumers they once were.
Meanwhile, domestic demand in China hasn’t taken off at the rate they expected. It turns out their own citizens are growing older and want to salt away more of what they earn for the future.
It’s a deflationary trend we’ve been warning about for years.
Western nations face similar problems. In Europe as well as the U.S., our central banks have burned the midnight oil to insure economic growth.
To this aim, they guaranteed bank profits through high net interest margin (long interest rates minus short interest rates), as massive amounts of capital were stripped from savers through negative interest rates.
The ammunition in this fight was newly printed currency. Trillions of dollars and euros later, here we sit, wondering when our economies will return to their previous glory.
We have other ailments. Oil production was a saving grace just a year ago, now it’s talked about as a curse. Rising production is driving down prices, which in this upside-down world of economic unreality is thought of as a bad thing.
When in history did governments wish for, and actively pursue, inflation? This stated policy goal guarantees the erosion of accumulated wealth, and yet our governments yearn for it. Crazy!
All of this comes back to the same idea. It’s not just one thing weighing on markets around the world.
It’s the multitude of issues faced in many nations. They’re dealing with aging populations, bubbles based on debt, and the misguided but unrelenting belief of policy makers, that if they only try one more monetary policy change, they can turn the economic tide.
Investors now realize this isn’t true, and there’s no way to estimate exactly how far out the tide will go.
Hopefully most investors have taken steps to avoid some of the carnage. While keeping some funds in equities as the markets marched higher these last few years, we’ve also pointed to cash and high quality fixed income as good hedges against an imminent downturn.
For those who haven’t taken such steps, this has been one heck of a wake-up call!
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