LONDON – When the banking crisis crippled global markets seven years ago, central bankers stepped in as lenders of last resort. Profligate private-sector loans were moved on to the public-sector balance sheet and vast money-printing gave the global economy room to heal.Time is now rapidly running out. From China to Brazil, the central banks have lost control and at the same time the global economy is grinding to a halt. It is only a matter of time before stock markets collapse under the weight of their lofty expectations and record valuations.The FTSE 100 has now erased its gains for the year, but there are signs things could get a whole lot worse.
1. Chinese slowdown
China was the great saviour of the world economy in 2008. The launching of an unprecedented stimulus package sparked an infrastructure investment boom. The voracious demand for commodities to fuel its construction boom dragged along oil and resource-rich emerging markets.
The Chinese economy has now hit a brick wall. Economic growth has dipped below seven per cent for the first time in a quarter of a century, according to official data. That probably means the real economy is far weaker.
The People’s Bank of China has pursued several measures to boost the flagging economy. The rate of borrowing has been slashed during the past 12 months from six per cent to 4.85 per cent. Opting to devalue the currency was a last resort and signalled that the great era of Chinese growth is rapidly approaching its endgame.
Data for exports showed an 8.9 per cent slump in July from the same period a year before. Analysts expected exports to fall only 0.3 per cent, so this was a huge miss.
The Chinese housing market is also in a perilous state. House prices have fallen sharply after decades of steady growth. For the millions who stored their wealth in property, it makes for unsettling times.
5. Credit rollover
As central banks run out of silver bullets then, credit markets are desperately seeking to reprice risk. The London Interbank Offered Rate (Libor), a guide to how worried U.K. banks are about lending to each other, has been steadily rising during the past 12 months. Part of this process is a healthy return to normal pricing of risk after six years of extraordinary monetary stimulus. However, as the essential transmission systems of lending between banks begin to take the strain, it is quite possible that six years of reliance on central banks for funds has left the credit system unable to cope.
Credit investors are often far better at pricing risk than optimistic equity investors. In the U.S., while the S&P 500 continues to soar, the high-yield debt market has already begun to fall sharply.
Reading this article in its entirety is worthwhile as it explains succinctly numerous economic and financial challenges that are looming.
As today's minutes from the Federal Reserve show, central bankers are becoming less confident the US economy is strong enough after 7 years to withstand a small 0.25% interest rate hike from the zero level.
China's surprise move to devalue the Yuan gives us some idea to the true weakness appearing in its export dependent economy. With an underdeveloped demand for its manufactured goods locally, collapsing export demand means big trouble rippling through all levels of its economy.
Now a high US dollar is importing deflation from the BRICS and the Fed wants to raise interest rates? Somehow this seems an unlikely scenario unless done for purely political purposes.
We need to continue to watch and even participate in the precious metals market to offset the risks of the general market which is in the sixth year of a bull market. Certainly the gold market is starting to look a little extended here as it recovers from a very low level, but longer term, the yellow dog looks like it will hold its own against fiat currency devaluation and central bank experimentation.
Of interest is the behavior of the central bank of Russia over the past few years. They have accumulated a very large stockpile of gold even as the spot price dropped since 2011. We suspect they will be in a stronger than anticipated position when the great currency reset occurs a few years from now.
Let us be mindful of the autumn period this year, as risks are higher than usual in this late stage of the bull market. Remember, cash is a position. It makes little sense to hang on to a stock that pays a 4% dividend and watch its price decline by 40 or 50%.