The triple discontinuity in China’s currency policy, oil prices and the US monetary stance poses a stern challenge to the world’s leading central banks. If they fail to restore confidence, the risks will grow of a protracted period of subpar growth and uncomfortably low inflation—a toxic combination known as secular stagnation.
Ironically, each of the dislocations can be interpreted positively. Beijing is allowing market forces to play a greater role in determining the renminbi’s exchange rate. Cheaper oil leaves Western consumers with more money to spend. And the fact that Federal Reserve policy is no longer on an emergency setting confirms the US economic recovery is well-entrenched.
Put the three changes together, however, and they add up for investors to a world where the old certainties no longer apply. Hence the sharp fall in equity prices since the start of 2016.
Of the three deep-seated changes, the most disconcerting is Beijing’s new currency regime because it is the least understood. The People’s Bank of China (PBOC) has done a poor job of explaining its apparent abandonment of a decades-old dollar peg in favour of tracking the renminbi’s value against a basket of currencies. Even the International Monetary Fund has asked the central bank to make its intentions clearer. Markets hate uncertainty, so they can be forgiven for fearing that the renminbi’s drop against the dollar since the start of the year—even though it has remained broadly steady against the new currency basket—presages a bigger depreciation that would squeeze rival exporters in the rest of the world.
The suspicion that Beijing might be ready to let its exchange rate fall plays into long-standing fears that the Chinese economy is slowing more abruptly than the authorities acknowledge as they try to make a transition from investment-led to consumption-led growth. Although the rise in GDP slowed to 6.9 per cent in 2015, China added much more to global output than it did in 2010, when the economy was still growing at a double-digit rate. Nonetheless, the impact of reduced investment on countries that supply natural resources to China is stark, as Brazil’s deep recession shows. A mounting risk is that companies in emerging markets will be unable to repay dollar-denominated loans now that their currencies are tumbling. The Russian ruble plumbed a record low on Thursday.
If China does cheapen the renminbi, it will in effect be exporting deflation by helping firms to lower their export prices so they can find overseas buyers for goods surplus to requirements at home. China’s exorbitant investment has saddled it with so much excess industrial capacity that producer prices are falling by 5.9 per cent a year.
This fear of global deflation is all the more acute because of the 70 per cent fall in the price of crude over the past year due to Saudi Arabia’s determination to bring other oil producers to heel by refusing to curb output in response to softer demand from China and others. The oil price crash should be a boon for consumers, but the US personal savings rate has actually risen since 2014. Americans may still start to spend more freely once they are sure that cheaper energy is here to stay. After all, the drop in oil has been precipitous.
But for now, their wariness—a hangover from the 2008 crisis—is yet another reason for companies to be correspondingly cautious about investing. Oil producers, of course, have slashed capital spending as prices have crashed, adding to the global gloom. Too much saving and too little investment is a good description of secular stagnation, for which the textbook response is lower inflation-adjusted interest rates to stimulate investment and spending. Yet the official rates of many central banks are already near zero, if not negative.
What to do? The European Central Bank (ECB) has all but promised further stimulus in March, and a media report on 22 January suggested the Bank of Japan could also relax its policy further. As for the Fed, it may already be regretting December’s rate rise—a landmark event that was still roiling global markets even before the latest swoon. A second rate rise in March, confidently expected at the end of 2015, is now unlikely. Some traders speculate the Fed will be forced to reverse the increase. Whatever it does, the Fed’s credibility is on the line at a time when the PBOC’s poor management of the renminbi—plus Beijing’s ham-fisted attempts to prop up the stock market—has already eroded confidence in global policymaking.
Investors want to believe that central banks can ride to the rescue again, as they have many times since the crisis—hence the sharp relief rally at the end of the week prompted by the ECB’s hint of more stimulus. But there is also an uneasy feeling that central banks are running out of options—hence the mutterings that what is happening in China and the oil markets is the signal of a deep malaise in the world economy.
Against this background, February’s gathering in Shanghai of finance ministers and central-bank chiefs from the G20 could shape up to be one of the most important policy meetings for quite a while.
This article was originally published in Newsweek.
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