Stock Markets Slump Worldwide

Stock Markets Slump Worldwide

The Wall Street Journal reported Friday on the worldwide slumping stock indices. In the United States the Dow Jones Industrial Average fell nearly 280 points or 1.5%. In Germany the DAX fell over 2.6% with France’s CAC dropping 1.6%. The decreases were not confined to the West with Japan’s Nikkei losing 1.2% and the Chinese stock market down over 5%. This worldwide slump indicates investors are running scared.

In addition, European bond markets are in turmoil. The yield on Greece’s 10 year bonds on Friday was 12.49%, while yields on its two-year bonds were over 26%. This perverse and inverse yield curve demonstrates substantial fear in the short-term relating to Greek finances.

According to the Journal, investor concerns center around three issues: 1) Greece’s financial situation, 2) China’s recent crackdown on stock market borrowing, and 3) weak in US corporate earnings.

As for the Greek financial crisis, this is an unresolvable problem without significant pain. Greece owes more debt than it can afford to pay back period. In addition, its economy has been rendered uncompetitive by the unnatural imposition of the euro on European economies. The European Union’s answer is to kick the can down the road by extending Greece’s loan repayment schedule. Each time and extension is given, equity markets sigh relief and bounce back only to be rattled when the extension runs out. Sooner or later the central bankers will have to admit the obvious, Greece’s debt will have to be written off with negative consequences to lenders worldwide.
The Chinese economic miracle has been built on the backs of cheap labor and significant debt used to inefficiently over build factories and cities. Chinese labor prices have been increasing. It is only a matter of time until a significant correction will be required to correct the imbalances created by imprudent use of debt.

Finally, the policies of the Federal Reserve and other central banks have resulted in an unnatural appreciation of the US dollar. While this has some positive implications, such as dropping oil prices, it also offers negative consequences. One such consequence is that US manufactured goods sold in dollars become uncompetitive in the world market. This leads to the third problem raised by the Journal, dropping US corporate earnings.

The problems that currently concern equity markets are the result of unnatural interventions by central banks and governments in their attempt to alleviate economic pain resulting from the 2008 meltdown. This meltdown was intern caused by the same central banks making credit available at artificially low rates and creating excess liquidity vis-à-vis poor lending practices. Had the central banks allowed the markets to take corrective action in 2008, while the initial recession/depression might have been deeper, the rebalancing of supply and demand would allowed for a stronger recovery. Instead, the economies worldwide jump from one problem to another and with investors then waiting for still further central bank corrective actions. Sooner or later this central bank alchemy will cease resolving problems even in the short run.

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China’s Growing Debt

This Blog has often referred to the real and potential problems associated with the growing debt in the United States and Western Europe.  However, the unsustainable growth of debt is a worldwide phenomenon that includes the fastest-growing major economy, China.

china debtThe Wall Street Journal reported on China’s growing debt.  According to the International Monetary Fund, China’s debt is growing quicker than that of Japan, who has a debt to GDP ratio of over 200%.  It is also growing faster than the debt of the United States and South Korea.

A significant portion of China’s debt is being created by local governments who borrow to finance projects in their areas.  The Journal reports that these local governments have accounted for 25% of China’s total debt since 2008 and in 2013 reached 36% of GDP, double the rate of five years earlier.  At this rate it is estimated that local borrowing will increase to 52% of GDP by 2019.

Incredibly, there are approximately 8,000 local quasi-government finance organizations throughout China.  This huge number and the large amount of debt lend themselves towards corruption and inefficient usage of the debt.  Also, since these finance organizations are related to the government, they are able to sell bonds with high risk at subsidize rates as lenders incorrectly believe that default is not possible.

This lose money policy in China lends itself to financing ventures that do not make economic sense, thereby increasing the likelihood of defaults.  This is eerily reminiscent of the lose money policies of the West and the United States in particular that led to the economic meltdown of 2008.  It is likely that China’s flawed financing practices will lead to similar results in that country.  Given the size of the Chinese economy, that will lead to contagion in economies worldwide.

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