The wild swings of stock markets around the world today should caution anyone against reading too much into recent global financial turmoil. As should be obvious to everyone – but is so easy to forget – these stock market declines are anything but the first that have been seen, and they’re anything but the worst that have been seen. The same goes for the economic situation in China and elsewhere – which matters much more.
But although this clearly is no end-of-the-world moment or even close, the latest news is a warning that the dangerous weaknesses that plunged the world into genuinely terrifying financial crisis and then savage recession just seven years ago have only been papered over, and have begun worsening again. More seriously, the United States and the rest of the world look much less capable of resisting powerful downdrafts.
Just to review very quickly, as I see it, the last crisis resulted fundamentally not from failures to regulate Wall Street adequately, the housing bubble, or any largely financial conditions. These were simply symptoms of mounting weaknesses in America’s real economy stemming largely from disastrously shortsighted trade policies. Both major parties became so enamored with offshoring-friendly trade deals and other policies that they sent overseas a critical mass of the U.S. productive base, and therefore a critical mass of the income-earning opportunities available to middle- and working-class families.
The George W. Bush administration, the Congress, and the Federal Reserve under then-Chairman Alan Greenspan could have reversed or even slowed this trade policy approach in order to restore these crucial domestic sources of income- and wealth-creation. Instead, they decided to double down on the offshoring. But to enable consumers (who are after all voters) to preserve their living standards, they decided to create then-unprecedented amounts of easy money, which made possible substituting borrowings (typically based on the bubble-ized home prices) for inadequate paychecks. Until that bubble’s inevitable bursting, the results were widely praised as having produced an economy whose “fundamentals” were “strong.“
Once the crisis struck, the Fed and other major world central banks have sought to reestablish and preserve national and global economic momentum through yet greater money printing and thus credit-creation. National governments in the United States (during President Obama’s first year in office) and especially in China lent a big hand through stimulus programs aimed at creating new government-supported demand for goods and services, and therefore for workers.
Seven years later, the results are in, and it’s fair to say that they have produced growth and employment levels that keep lagging historical standards not only in the United States, but everywhere. In fact, largely because the Fed so quickly and energetically capitalized on its massive credit-creation powers, America is a conspicuous out-performer. But as I’ve also pointed out, the makeup of the U.S. economy still strongly resembles that of the housing- and consumption-heavy bubble decade, which is why a more compelling description of America’s situation is not “ho-hum recovery” but “secular stagnation.” This concept, popularized by former Clinton-era Treasury Secretary and Obama chief economic adviser Larry Summers, holds that the nation has lost so much productive oomph that it’s forced to rely on Fed-created bubbles for whatever growth it can muster – and thus to run the ongoing risks of bubble-bursting as well.
Something, though, has clearly changed in recent weeks. The one-word description is “China” but the real answer is of course much more complicated, and looks to be a function of a seemingly fatal flaw of global easy-money policies: They’ve fostered way too little productive, growth-boosting investment, and way too much mal-investment. The latter has barely kept growth in positive territory but that’s gifted Wall Street and executives at big publicly traded companies with huge windfalls thanks to a (so far) mutually reinforcing cycle of share buybacks and rising stock prices that has supercharged their largely stock price-based pay. Other uses for cash and credit that have seemed more tempting than servicing economically fragile and in many cases still-cautious American consumers included buying up other companies and, mainly for Wall Street, simply parking the money at the Fed, where big finance firms could earn a bit of interest on trillions of dollars for doing absolutely nothing.
But still other distorted investment choices have included so-called emerging markets. In those lower income countries, higher levels of risk brought attractive levels of return, but investors (and not just financiers) were also impressed with relatively high growth rates. And that’s where much of the latest round of troubles is rooted.
Several big and chronic weaknesses and vulnerabilities of these countries – including China – were largely overlooked. First, because incomes were comparatively low, these countries were never able to grow mainly by turning out goods and services for their own populations. Growing fast enough to spur significant economic progress required finding markets “where the money is,” which meant abroad generally and disproportionately in the United States. When growth in the United States merely kept slogging along, many of the new factories that were built with American consumers in mind began looking awfully risky.
Just as bad, many of these emerging market countries themselves got greedy. Their governments and central banks took advantage of low global interest rates by trying to juice extra growth and rising incomes by offering easy credit to their consumers, home-builders, and other businesses, too. But they weren’t able to borrow sufficiently in their own currencies, and many jumped at the chance to take on abundant dollar-denominated debt – including companies that could borrow on their own, without working directly through their governments. Moreover, many of these low-income countries (and some wealthy counterparts, like Australia and Canada) had gotten an added boost from China’s seemingly endless demand for their raw materials, which produced the lion’s share of their growth. But they failed to use earnings from the resulting high commodity prices to diversify their economies and take at least a few eggs out of that basket.
Lately, both China and the Federal Reserve have hit the emerging world with several punishing whammies. China itself continued to depend heavily on exports for its growth, and therefore started slowing itself as global demand continued disappointing. Its performance was additionally undermined by a decision to let permit the yuan to strengthen, in order to win it reserve currency status and greater long-term economic independence.
Beijing had also been trying to subsidize more growth led by domestic demand. But as with other third world countries, because Chinese incomes remain so low even after impressive pay raises, massive amounts of stimulus ranging from infrastructure and housing investment to (most recently) stock market manipulation did more to saddle that country with immense debts than to keep growth and job-creation at levels that were both economically acceptable, and politically essential – i.e., strong enough to keep the masses reasonably happy.
If official data is close to accurate (hardly a certainty), China’s growth rate is still world-class. But even its recent decline from previous blistering levels clearly has been enough to ravage global demand for fuels, industrial metals, and foodstuffs alike – and in turn the economic prospects of the commodity producers. Since the economic prospects of these erstwhile johnny-one-note high-riders began worsening so markedly, foreign investors began pulling money out, putting downward pressure on their currencies, and consequently on their ability to import – including from the United States. At the same time, China’s own recent yuan devaluation deepened this predicament – by further diminishing the PRC’s own purchasing power, and by reducing the price competitiveness of all the finished goods that the commodity producers and their more manufacturing-oriented third world counterparts needed to sell.
If anything, the Fed’s impact on the developing world has been still more destructive. Like the United States, much and even most of its recent growth has depended on artificially cheap credit. But unlike the United States, it can’t borrow in its own currencies. As a result, these countries are exposed to exchange-rate risk (created mainly by the rising dollar) as well as to interest rate risk (which can be created not only by the actual Fed interest rate hike that Chairman Janet Yellen and colleagues have been promising, but by a perception of impending hikes that reduces the third world’s creditworthiness and thus their access to affordable new money.
The real U.S. economy is more than capable of staying relatively unscathed by this global turmoil. For despite the best efforts of American leaders, it’s still less reliant on trade, foreign investment, and the well-being of the rest of the world than practically any other economy. U.S. stock markets, by contrast, could be in for greater trouble, which could be the single most important reason for their recent drop (keeping in mind that their levels are always determined by a great variety of long and short-term influences).
The reason? Among the major props for stocks during the current feeble U.S. recovery has been American companies’ remarkable ability to grow profits despite the real economy’s woes. As widely noted, much of this growth has been on the bottom line – resulting from greater efficiencies rather than better revenues. Human ingenuity’s power should never be underestimated, but by the same token, it’s hard to believe that infinite amounts of blood can be drawn from that stone. Indeed, faltering recent American productivity performance strongly indicates that diminishing returns are in store for these efforts. Emerging markets, with their historically high growth rates and gargantuan populations, have long been viewed as business’ best future hope for accelerated top line growth, and so far they’ve performed well enough to justify considerable confidence.
This latest set of emerging market troubles, including China’s, signals that this ace in the hole really isn’t – which understandably raises questions about whether current stock valuations can be sustained. As usual, please take all forecasting efforts, including mine, with a big boulder of salt. But it seems to me at least conceivable that, just as Wall Street has for years comforted itself by observing that “the stock market is not the economy,” unless Washington screws up royally, Main Street will start becoming grateful for this divide.
But that doesn’t mean that a healthy speed up in the recovery is in sight. Speculation has abounded lately that the Fed might not only postpone those interest rate hikes but need to launch another round of bond-buying – i.e. “quantitative easing.” Yet why a new influx of easy money would generate more sustainable growth than its predecessors isn’t at all apparent. Washington could return to greatly increased deficit spending, but with so much of U.S. consumer and business demand being satisfied by imports, and with foreign currency devaluations likely to continue, the growth and employment benefits seem more certain than ever to leak overseas. In principle, this new spending could be targeted on domestic infrastructure, but however popular this idea has been in Washington, it hasn’t yet been popular enough to produce enacted programs, and the intensifying presidential cycle could well turn into a new obstacle.
What about tariffs on imports, which could spur growth by cutting the trade deficit – and without budget-busting tax cuts or stimulus programs? As usual, they’re completely off the table. Indeed, new trade agreements, and therefore higher deficits and even slower growth, appear to be next on that front – though perhaps not until both Democrats and Republicans are safely past the next election.
That leaves fostering an unhealthy speed up in the recovery – kicking the can down the road yet again secular stagnation-style, for the usual unspecified reasons expecting meaningfully different results, and acting surprised when crisis clouds begin gathering anew.
