Wednesday 22 July 2015

China - staying out of the news

A tumble in stock prices gives rise to more worries about China but it is not deserving of the bad press

News about China often hits the front pages as its swift rise is both scary and a source of economic salvation.  Stock markets in China have been making news recent due to a sharp selloff in shares.  The media are quick to jump on any potential hiccup in China’s rapid expansion due to its growing importance as a global economic superpower.  Yet, the peculiarities of stock markets in China mean that the spill over effects are likely to be limited even though the financial sector will continue to be a source for headlines in the future.

New to this game

Picking the right stocks and when to buy them is never easy but it is even trickier with China being a relative newcomer to trading shares.  The shorter the period of time over which shares have been traded, the more difficult it is to pin down what should be paid for stocks.  Many of the companies themselves are also still young and are still fighting a fierce battle with rivals for survival.  On top of this, the bulk of the investors in the Chinese markets are locals and have less experience in trading stock. 

The government further muddies the picture with its plans for liberalising the financial markets.  While fewer restrictions would be welcomed, the reforms create jitters due to the potential pace of change depending on the whims of its leaders.  Yet, the government regulations in themselves are part of the problem.  One issue is limits on how much banks can pay out in interest on savings accounts.  Starved of other places to put any spare cash, too many Chinese look to make money in domestic share markets which are ill equip to deal with the inflows.

While many eager investors have managed to sidestep the barriers, heavy regulation of the financial markets keeps out many more Chinese.  This has the effect of limiting any losses when the inevitable selloffs hit the stock markets.  In this way, the government ensures that the underlying economy is sheltered from any volatility in the stock markets.  Neither is the stock market much of a reflection of what is going on in the actual economy.  Chinese stock prices had stagnated for a long time prior to the recent ups and downs so it is unlikely that any bad news in the stock markets will be a prelude to trouble with the economy.

Watch this space

All this would not make the headlines if happening in any other emerging market but China is a big deal these days.  Its importance as the main global driver for economic growth makes outsiders nervous.  Its haphazard mix of free market and government control means that pessimists are quick to spot its faults.  But, just like with the patchy rules governing financial markets, the government has adapted in the past to stay on top of problems before things get out of hand.


The fear of market turmoil spilling over to society at large will continue to keep the Chinese on a cautious path to freeing up financial markets.  Over this time, China will continue to be plagued by a jumpy stock market as its investors grow used to the ups and downs of share prices.  Considering that even Western investors have not fully mastered this, the trials and tribulations of Chinese share prices will likely to be hitting headlines again many times in the future.  But, with government policy helping to stem the spread of any losses, it is not something that needs to cause too much worry yet.

Friday 3 July 2015

Central Banks – juggling interest rates and inflation

Low inflation is dampening the effects of low interest rates and central banks are happy to let this happen

As guardians of the economic recovery and a bulwark against inflation, central banks have a tough juggling act to maintain.  This is made even more difficult as priorities shift from getting the economy moving again to keeping an eye out for inflation.  The consequences of this can be seen in central banks’ tolerance towards low inflation with low interest rates proving less helpful as prices remain depressed.  Central banks are letting this happen due to inflation being one ball that central banks dare not come close to dropping.

Too many balls in the air

Central banks have a lot of balls in the air to watch with their remit including managing the price level as well as ensuring stability in the financial markets (and maintaining employment levels in the US).  The number of balls has increased as monetary policy has become the main way to bolster the economy with governments in many countries refusing to use fiscal policy.  But it is inflation that typically remains the main focus of central banks. 

The aversion to inflation was put to one side amid the turmoil of the global financial crisis.  Efforts to prop up the money supply through quantitative easing would have normally also lifted prices but this did not stop central banks taking bold action.  As the threat of crisis has receded, so have measures by some central banks to help out with the economy.  This shift has been made more pronounced due to low inflation as depressed prices strip away some of the positive effects of low interest. 

Juggling priorities  

The rate at which prices are rising affects decisions made by companies on whether to borrow money.  Higher inflation makes low interest rates more attractive to businesses as any products purchased today will be worth more in the future making it easier to pay off debts.  The opposite is also true and flat prices will prompt some business putting off plans to borrow and invest.  The harm done by low inflation is even more pervasive if it is a reflection of a weak economy which seems likely

By not doing more to keep prices ticking upwards, central banks are consenting with some of the potential effects of low interest rates being taken away.  It is like a hike in interest rates without interest rates actually having to rise.  It is a sign of how much central banks worry about prices rising too fast that this is happening despite the economic recovery still lacking momentum and inflation close to zero.

Don’t douse the economic recovery

The various roles of the central bank can make it seem as if they are required to juggle fire and water at the same time.  Much has been left to central banks in the aftermath of the global financial crisis which has often resulted in monetary policy being pushed too far.  Central banks were never meant to take such an active role in managing the economy.  A return to their less controversial role of keeping a lid on inflation will come as a welcome relief.  It is, after all, their record on inflation that central banks will often be judged. 

However, it is still too soon to move against the potential threat of a jump in prices.  There is still scope to leave interest rates at their current low levels with other measures such as macroprudential policies available for sectors, such as the residential property market, where lending is getting out of hand.  There is a point in every juggler’s routine where everything seems set to come crashing down – let’s hope that this does not happen due to a premature hike in interest rates.