photo by Francisco Carbajal
The U.S. stock market took a dive in the spring of 2013 at the first hint that the Federal Reserve was on track to taper off its ultra-easy-money quantitative easing program and, thereafter, begin raising interest rates. The brief but short-lived plunge came to be called the “taper tantrum.”
Markets slid again last fall amid fears that U.S. economic expansion was on the verge of stalling. The histrionics culminated on Oct. 15 in what CNN called a “freak out,” where stocks plunged at midday, only to recover a large share of the loss by the closing bell. Again the alarm was short-lived; all was forgiven and forgotten by Christmas.
As a matter of fact, we have had some sort of sharp market decline in every year since 2010, when it was finally clear that stocks had genuinely rebounded from the depths they reached a year earlier after the financial panic.
So I view last week’s carnage in the markets with a feeling of deja vu. The Standard & Poor’s 500 index of large U.S. stocks dropped 3.2 percent on Friday and more than 6 percent for the entire week, taking it down about 7 percent from the highs it reached earlier this year. Along with declines around the world, that made it the worst month in the markets since, well, all the way back to 2011.
That’s right. From all appearances, this was yet another hiccup in what has been a six-year bull market, sustained in part by an improving economy, and also in large measure by the Fed’s ultra-low interest rates.
Of course, just because markets have quickly recovered in the past does not mean they will this time. Some downturns are genuine harbingers of recessions, from which stock prices, along with the real economy, take considerable time to recover. There have been three of those really big downturns in my adult life: in 1973-74, with the first Arab oil embargo; in 2001-2002, with the end of the dot-com bubble; and in 2008-2009, accompanying the global financial meltdown.
The mere act of listing those three events helps to distinguish such moments - points at which the underlying condition of the world and its economy changed in some substantial and fundamental way - from the present. There simply is nothing happening right now that compares with those turning points in scale and scope, and thus it strikes me as unlikely that we are entering a similarly deep and extended downturn.
There are three big things spooking the markets right now. One is the anticipated start of a series interest rate increases by the Fed, which until now seemed likely to begin concurrently with the Fed’s upcoming September meeting. The second is the increasingly obvious economic slowdown in China, whose hallmark was this month’s abrupt devaluation of the yuan. And the third is the collapse in many commodity prices, most notably the price of oil, which is now down nearly 60 percent from last year’s levels.
The first item - an imminent interest rate increase by the Fed - has probably been taken off the table for now by items two and three. I think it is quite unlikely that the Fed will raise rates next month. This is a highly risk-averse central bank, which has held rates at unheard-of levels for nearly seven years rather than face the hazard of acting too soon and sending the economy into a collapse. Conceivably, it could have acted earlier this year, when employment growth was strong and China’s policy was still to keep its currency strengthening in lockstep with the dollar. The Fed was afraid, then as now, that raising rates would undermine its efforts to bring inflation back to a 2 percent long-term target.
Raising rates now would amplify those concerns. Higher rates will tend to strengthen the dollar, and thus inhibit inflation, by holding down prices of imported goods. A stronger dollar likewise tends to depress the price of oil, which is quoted worldwide in dollars - and lower oil prices mean lower inflation. Raising rates also would risk further frightening the stock market and undermining the confidence of U.S. consumers, who are only tentatively tiptoeing back to the stores, car dealerships and shopping websites. The Fed now has every reason, from its perspective, to hold off again on raising rates. I think that is exactly what it will do.
China, as I have written before, is in more economic trouble than its leadership is willing to let on. Its internal debt is enormous, its banking system is fragile and its system for moving capital to productive parts of its economy is distorted to the point of dysfunction by political interference. A vast debt-fueled capital spending boom helped support global commodity prices and resource-exporting economies for years. That party is ending, and nations like Australia and Brazil are feeling the hangover.
Yet China has vast foreign capital reserves and could conceivably snap back from its doldrums in fairly short order. Even if it does not - and I think there is a significant risk it will not - China is not the only growth engine for the world economy. In fact, taking away its capital spending boom that is clearly about to go bust, China is not even a very good engine, since apart from infrastructure spending its economic prowess is built on exports. In these respects, China looks a lot like Japan did some 25 years ago. The world survived Japan’s long-term malaise by finding new growth in developing countries. That may well happen again.
Depressed oil prices hurt oil producers like Russia, Saudi Arabia, Iran and Iraq, but they help nearly everyone else. As a leading consumer, China will benefit from the decline in commodity prices. So will India and the rest of Asia, much of Latin America outside Venezuela, and most of Africa. So, too, will Europe, and even the United States, for although we have become a leading energy producer, we are still a net consumer of energy produced elsewhere. Moreover, unlike China, ours is a consumer-led economy. We can make up some of China’s falloff by adopting more growth-friendly policies here, which is something next year’s election may address.
It is worth remembering something every parent knows about tantrums: They soon pass, and things get back to normal. Chances are good that this month’s stock turbulence is just such a tantrum, and that it will be over soon enough.