Monday, January 11, 2016

Financial market jitters: real or imagined?

I made the point a couple of days ago that projected global economic growth is line with long-term trend growth of 3% despite the problems in China. Are the markets seeing ghosts? FT columnist Gavyn Davies appears to think so:
Market fears of a global recession this year seem to be rising, if we are to judge from the way in which asset prices have been behaving. But so far there is little sign of a recession starting, either in our “nowcasts”, or in hard data for industrial production and retail sales. The global activity growth rate is estimated at 3.1 per cent, which is slightly higher than the 2.6 per cent rate recorded when markets collapsed in August/September last year. Although this is not a significant difference, the direction of change is informative. If the Chinese and other emerging market economies were dragging the world into recession, it would surely be showing in a generalised weakening of activity data, rather than the opposite.
Larry Summers, however, thinks the markets are on to something:
Policymakers who dismiss market moves as reflecting mere speculation often make a serious mistake. Markets understood the gravity of the 2008 crisis well before the Federal Reserve. They grasped the unsustainability of fixed exchange rates in the UK, Mexico and Brazil while the authorities were still in denial, and saw slowdown or recession well before forecasters in countless downturns. While markets do sometimes send false alarms and should not be slavishly followed, the conventional wisdom essentially never recognises gathering storms....Because of China’s scale, its potential volatility and the limited room for conventional monetary manoeuvres, the global risk to domestic economic performance in the US, Europe and many emerging markets is as great as at any time I can remember. 
A Chinese collapse has been forecast for so many years now that we should not be surprised if Summers and his ilk are proved wrong. There is a Chinese slowdown but no collapse in sight as of now. What is happening, as I have argued earlier, is that investors cannot make sense of the events because heightened political tensions spell greater uncertainty.

So, yes, the markets are conveying something. But that something is not a sharp slowdown in global growth but a sharp rise in political tensions that render investment decisions more difficult than before.

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