Has the Great Fall of China run its course?

China fears are now more history than prophecy and the US and Europe, have expectations. The eventual arrival of higher rates in the US will indicate good real economic conditions for businesses and those who work for them. It’s only the ashen-faced troglodytes of financial caverns that fear them. Don’t confuse the former with the latter. Even Europe may be awakening from its deep economic sleep.

As we drove into September through the late August rain – if you live in the UK and in overcast London in particular – you ask yourself (whilst humming that Rogers and Hammerstein sweet song offering the advice to ‘whistle a happy tune whenever you are afraid’), are markets driven by fundamentals or something else?

The fact is of course, they are driven to a major extent by the short term self interest of large investment banks who need liquidity like the late – at least I hope he is ‘the late’ – Count Dracula, formerly of Transylvania, needed blood, to sustain existence. Their market making and trading operations live day by day, for small margins of profit, with which to make large absolute gains from which to recover their high earnings and operating costs, and keep the show on the road. High frequency trading is the purest essence of this approach to markets. They are simply not long term investors!

In modern markets, the small, quiet voice of reason is constantly drowned out by a great cacophony of interpretations of changing economic and other data. It’s like several orchestras and half a dozen great choirs competing with each other a misbegotten, mad descant version of Hayden’s ‘The Creation’. Everything and everyone is short term. Alternatively, it is like living in a town which has a constant daily revolution with both sides losing and gaining small margins of ground to the sound of megaphone dogma and propaganda which reduces the cowering inhabitants dizzy from confusion.

So put in the ear plugs, have a cup of tea and think calmly. It may not necessarily give you the right answer but it will give you a considered one. Don’t just react to every event. That only favours those who have anticipated such events. Try to work out where we have got to and what comes next, in a quiet sort of fashion. Chasing crowds, sometimes works, as most things do from time to time, but it is no substitute for exercising rationality.

China

We have just had the umpteenth act of the great China drama in which the Chinese real economy spins out of control to collapse as a pile of rubble. Very few saw the collapse of the western banking system in 2007 – including the then Chairman of the US Federal Reserve, and the IMF – but many in the market have seen and preached the many times collapse of Chinese economy over the last five years. The fact it has not yet actually collapsed tells you something!

That is not to say that China and its economy is not at a cross roads as it manages its move from being an infrastructure-led economy, into something which will gradually and increasingly turn into something more closely resembling a broadly based consumer society economy. It is worth repeating that some commentators still, amazingly, express alarm that the Chinese economy will not keep on growing at 10% p.a. That expectation, as a realistic and rational one, disappeared a year or so ago, when it became blindingly obvious that future economic growth would be at around 7.0% – 7.5% p.a. for a number of years and then, under the laws of reasoned possibility, it will inevitably grow at a slower annual percentage rate, the larger and mightier it gets in absolute terms.

It seems to me that although some margin of scepticism is in order when it comes to pronouncements by Chinese officials about the Chinese economy, such doubts have to be set against the fact that those pronouncements over the last ten years and more seem to have been pretty reliable, by and large. One should be pragmatic enough to take that on board and not simply surrender to the latest individual theory of somebody or another in New York or London; someone whose own track cord is probably even more opaque to you than the obscurity of the working methods of Chinese government statisticians.

The latest official policy view from China

In that spirit, I draw your attention to the utterances of the Governor of the Central Bank of China over the weekend, when he told the G20 gathering in Turkey that in his view, the worst of the Shanghai stock collapse was almost over. He is probably right given the fact that it has fallen a monumental 40%.

He referred to the exchange rate of the Renminbi, reportedly saying that China had no policy long-term devaluation of the Renminbi. That may be regarded as good news. The authorities did say that the Chinese economy had grown less than expected last year but the downward revision was only from 7.4% annual GDP growth in 2014 to 7.3%. Unless you are one of those who think that it should have been 10% growth in the first place, the revision looks to be well within normal forecasting error. Having had its 40% fall, the Chinese share market will probably start to turn into a supporting bullish factor from here on in, so far as markets are concerned.

Today’s import and export figures out of China are pretty emphatic. Imports in August were down 14.3% and exports down 6.1%. But remember that the fall in imports was in part attributable to the fall in commodity and oil prices. Not to take note of that is double accounting bearishness. Moreover, these days such figures do not necessarily reflect the state of genuine economic demand, but increasingly the activities of “alternative investment” traders and the influence of derivative markets – and we seem to have seen a lot of them hopping into and out of the copper market, for example. The bullish news is that China’s trading surplus jumped by 40% in August. Although investors are expecting similar data in the next few weeks, that has probably been discounted. Chinese economic progress seems to have steadied and a notably over valued and over geared Shanghai stock market has largely had its much needed correction.

The US and Europe

The subject of these observations is China and what may come next. However, one has to be strategically tidy and make some foot note observations on the US and Europe. US non farm unemployment is down to just over 5% – the lowest such number since 2008. The bad news is that there is still too little wage and other inflation in the system for the taste of policy makers, leading to the subsequent so called “good” news that interest rates are less likely to rise now. What we really need is a higher interest rate from this super low level, because that will betoken more employment and wage growth good things in an economy where consumer spending has traditionally accounted for about 70% of GDP growth.

In the UK and Europe the blow to confidence has already impacted car and other manufactured exports, particularly at the luxury end. Until the China business, Europe was slowly stirring from it economic paralysis with doses of QE.

Conclusion

My conclusion is that the China thing has probably run its course, the US economy is still inflating, but without enough actual price inflation to help economic activity, and that Europe will probably continue to stagger slowly into the ranks of the economic undead.