One of the risks I pointed out the other day was China. As one of the largest and fastest-growing economies in the world, China matters for a lot of reasons—mainly, at this point, because it was the only one that seemed set to power forward and take the lead in the global recovery. I’ve long had my doubts about this, but that was the general consensus.
Last week, Chinese interbank borrowing rates—the cost that banks pay to borrow money from other banks—spiked, reportedly due to a cash shortage. Chinese banks called on the People’s Bank of China to inject more cash into the system and ease the shortage.
Although there were many reasons for the shortage, the primary one seems to be the amount of lending that Chinese banks have done. Unlike in the past, though, the PBOC issued a statement over the weekend saying it would not step in this time and chastising banks for poor management. The government explicitly wants to cut back on credit, so by limiting the cash it will inject, it is forcing banks to face the pain rather than bailing them out again. Unsurprisingly, the Chinese markets aren’t happy about this.
The parallel with the Fed’s actions is direct—both central banks are pulling back from stimulating the economy. The difference is that the PBOC is doing it now, with real money, to slow credit growth, and the Fed says it will start doing it if the economy continues to improve, which is a big difference.
The markets are not making that distinction. The Shanghai market was down more than 5 percent, and all of the major world markets are down as I write this. U.S. markets opened down and headed lower, and interest rates have continued to increase.
So far, this is part of a normal adjustment process, albeit a very painful one. The timing of the Fed and PBOC announcements is unfortunate. Even more unfortunate was the Bank for International Settlements’ annual report, issued on Sunday, which takes governments to task for not making necessary economic reforms and states that central banks cannot continue to carry the load. The global pullback of central banks is intensifying the impact of the Fed’s actions.
The question is, of course, will this adjustment continue and grow to a dangerous level? Ideally, we would have seen this play out over a longer time period, but there’s no implicit reason that a fast adjustment has to be more dangerous than a slow one. A possible risk is that the downward trend goes too fast and starts to feed on itself. There are no signs of this at present, although I continue to look for them.
I wrote on Friday that I considered continued declines probable, and that’s just what we are seeing, exacerbated by the Chinese situation. The trend is now down, and that will probably continue to be the case for a while. As of right now, though, this continues to be a normal, though fast, adjustment in the financial markets.
The real economy, meanwhile, seems to be continuing its growth pace here in the U.S. The Dallas Federal Reserve’s manufacturing activity survey just came in, climbing to +6.5 from its previous −10.5. I will be watching other indicators closely, but right now the recovery in the U.S. economy continues on track. As markets stop reacting and start thinking, the superior competitive position of the U.S. may become more apparent.
None of this is to say the adjustment process is over, just to call attention to the fact that, so far, it is normal. We can expect more turbulence ahead, but the fundamental factors remain solid at this point.