They like to call it a “dead cat bounce”. After two weeks of turmoil on world markets, culminating on Wednesday in a $30 billion rout on the Australian share market, stocks briefly rose yesterday morning before losing another $18 billion or so by the day’s end. Today could be worse, much worse.
Going into yesterday, investors had reason to hope for a bit of a local bounce after 12 falls in the previous 18 trading days. Even Wall Street managed to snap its eight-day losing streak, but things went sour again overnight causing a massive plunge in US shares.
Daily movements aside, we are back in a bear market again. Markets anticipate what happens in the real world. And if the recent spate of world economic statistics is any guide – whether GDP, trade, factory output or jobs – the world appears to be sliding into recession.
How could this be? Aren’t we just recovering now from the global financial crisis, you ask?
Follow the debt
In the financial crisis of 2008 it was the banks which had all the debt, and the governments which bailed them out. Fast forward three years and we have the sovereign debt crisis. Now the question is: who bails out the governments?
It was supposed to have been the people. The people, around the world, were meant to spend. They were meant to revive their economies by spending up big and generating growth.
Governments, whether in Europe, the US or Australia, did their bit to encourage this. They bailed out the banks, they cut interest rates to the lowest levels they could to fire up borrowers. They launched an array of stimulus programs. Here we had our “cash splash”, school halls and pink batts programs.
And it all worked … for a time
In the US, Main Street bailed out Wall Street. They spent trillions on rescue and stimulus programs. Share markets dutifully doubled from depths of the financial crisis in March 2009. Economic growth soon returned, bringing optimism that the next bull market had begun.
Alas, it was a false dawn. In Australia, shares quickly rallied 50 per cent from their March nadir. But this was no bull market, rather a mere uptick in a super bear market.
The problem was that the people didn’t do their bit. They didn’t spend. They saved instead. Saving is a good thing, except for economies struggling to recover from financial crises.
Household savings rates are at their highest level since the 1970s, yet household debt still remains high, particularly in Australia.
It jars with financial market etiquette to make the point but there is a haunting resemblance to the Great Crash of 1929, when Wall Street recovered in 1930 only to tank again, plumbing its depths in 1932 and not reaching its 1929 peak until 1954.
That crash brought the Great Depression. Governance and economic management are far more sophisticated these days so, even on a pessimistic view of current events, the prospect of food queues in our capital cities is implausible. Still, things seem bound to get worse before they get better.
On the markets
On Wednesday, US stocks eked out small gains, but only after rumours that the Federal Reserve – the equivalent of our Reserve Bank except that it is a private rather than a government agency – was considering yet another stimulus program. Last night was a different story with market losing 4 and 5 per cent – a bad night in anyone’s language. Markets in Europe also tanked.
The rub is that the US Fed has already spent more than $US2 trillion in what amounts to simply printing money. They call it “quantitative easing” or “QE” – a euphemistic nickname for what is in fact a precarious practice by which the US government buys its own debt as it issues bits of paper in the bond market.
In layman’s terms, the government is writing IOUs – they call these treasuries or bonds – to finance the business of government and then the US central bank (the Fed) buys them. The outcome is that the amount of money on issue expands. It is meant to kick-start the economy and reduce the value of America’s debt.
Now, with the disappointing rash of economic statistics of late, it is dawning on everyone that the value of the stock market has indeed been inflated and the world is sliding back into recession. The second round of QE stimulus ended in June. Since then, markets have tumbled.
Just as here, incidentally, retail sales and property prices stalled when government stimulus ran dry.
Debt-ceiling fight a smokescreen
Attention on world markets in recent weeks had been diverted by the raging debate between Democrats and Republicans over the debt ceiling. This had masked the real threat – the recovery was choking.
The debt-ceiling debacle was merely symptomatic of more profound issues. The massive public spending to save Wall Street and dig the US out of its deepest recession in fifty years had blown out the deficit and the national debt. Catch 22 – more public spending equals more debt while less public spending means a contracting economy.
Meanwhile, the same trend was occurring in Europe where the threat of Greece, and latterly Italy and Spain, defaulting on their debts had the Eurozone in crisis. Like the US, they’d cut interest rates as far as they could. The debts, or leverage, had simply been transferred from the private sector to the public sector. Now Europe had its sovereign debt crisis and there was no more room to move.
Where did investment go now? Europe and the US are in the same bind. If 2008 was the Global Financial Crisis, 2011 is the Great Deleveraging. The stimulus by world governments seems now to have been a bit of a band-aid solution. The reality is dawning that financial market values had been pushed artificially high by extra debt, or “leverage”.
In 1990, at the time of Australia’s last recession, debt averaged 50 per cent of household output. By the financial crisis it had shot to 160 per cent. The average household, thanks to the debt deluge by banks and credit providers, was leveraged or geared to the hilt. Government efforts to keep the property market and the mortgage boom going via the likes of first home owners grant only made this worse.
In 1990, they didn’t have much margin lending, nor geared share portfolios and the likes. All this leverage had propelled financial markets and the property market to unrealistic levels. Now it is unravelling, as evinced by the slowing in bank credit growth.
As Australia has the highest household leverage in the world it is extremely vulnerable should the China boom turn to bust. Even if growth slows in China and demand for our commodities falls, Australia is susceptible.
Hence the dead cat bounce. Despite the 2.5 per cent plunge on Wednesday and a further decline yesterday, the share market has failed to substantially recover its losses because, one, the outlook for the world economy is increasingly dire and, two, our saviour China is flat today and commodity prices are down. For investors, in the short term, the share market is due for recovery. It should be only weeks away though – and a few more rounds of world economic statistics – that we will find out whether the world is headed for a “double-dip” recession and Australia for its first real dip in twenty years.
The China question
For Australia, recession is no forgone conclusion. Our economic fate hinges on China. If China holds, Australia’s twenty-year purple patch without a recession may continue. The question is, will China hold up?
China is a planned economy run by a dictatorship so it can keep things going for a while even if things turn ugly in the rest of the world. The crux of the matter is that China is also a huge exporter to the world, the biggest, and if demand for its products slows – and this appears to be happening – it will have to resort to its domestic economy to keep demand going.
That same demand is keeping Australia’s resources boom afoot and delivering our standard of living.
Can it generate its own growth via internal demand? Some think it can. Others say it cannot continue to thrive in isolation. The recent exasperation in the Chinese leadership would suggest the latter. The Peoples Daily, the mouthpiece of the Communist Party leadership, slung off at the US for putting the world economy at risk by dithering on the debt-ceiling.
Russian president Vladimir Putin even weighed in too.
You can understand China’s concern. Apart from the US government itself, China is the largest owner of US debt in the world, holding approximately 8 per cent of treasury bonds on issue. That is an investment of $US1.2 trillion – or $US1.2 thousand billion.
It is enough of a worry that the US government and assorted agencies including the Fed hold $US4.6 trillion of their own country’s borrowings but the Chinese holding foreshadows the new world order. Own the debt and you control the asset, they say.
The demise of America is matched by the rise of China. Yet the inextricable links of globalisation suggest no country can prosper alone.