Tuesday, July 28, 2015

China's Financial Isolation

China's manufacturing sector is deeply embedded in the world economy, and has made China an economic superpower.  But China's government has isolated the Chinese financial system, and that turns out to be a good thing for the rest of the world.

China's stock market has fallen about 30% from its recent high in June 2015.  The impact on investors of this dizzying drop has been acutely painful, especially for recent entrants.  Many of those purchased on margin, and have taken crushing losses.  The Chinese government has announced various measures to pump more money into the stock market and stabilize prices.  The verdict on this blatant governmental effort to manipulate prices has yet to come in. 

However, the rest of the world hasn't felt much impact from the gyration's of China's stock market.  While foreign investors in Chinese stocks have taken losses, it's not that easy for foreigners to invest in Chinese securities.  Similarly, it's difficult for foreign banks to do business in China.  They wouldn't have that much at stake, since the Chinese government limits the scope of their activities.  Although foreign losses in China aren't trivial, they also aren't enough to destabilize the international financial system.

The Chinese government deliberately limited foreign access to the Chinese financial system, fearing the volatility seen in the 1997 Asian financial crisis, when Western capital exited, stage right, as things got stinky.  This rapid outflow of capital only made things worse for the developing Asian nations.  The last thing the Chinese government wanted to do was indenture itself to Western capital.

Of course, what the Chinese government did on its own was pretty silly.  It tried to use monetary and regulatory policy to stimulate the economy by pumping up stock prices.  This is unpleasantly reminiscent of U.S. government policy in the early 2000's to stimulate the economy by pumping up real estate prices.  The Chinese have greatly modernized their nation in the last 40 years by adopting ideas from the West, but imitation can be taken too far. 

Financial websites are filled with speculation about the supposedly dire consequences to everything in the entire world from the drop in Chinese stocks.  Not to be a cynic, but bad news is news and good news is trash left at the copy desk.  The most likely impact from the turbulence in the Chinese financial markets is an economic slowdown within China, and a possible economic slowdown in the rest of the world.  But the Chinese financial system won't collapse.  That's because the Chinese government, which owns and/or controls China's banks, can simply print money to recapitalize them.  Since the Chinese government controls trillions of dollars of foreign exchange, it can make sure that foreign banks having exposure to Chinese financial institutions aren't left in the lurch.  The Chinese can't let their stock market gyrations take down the rest of the world's financial system, or they won't have any export markets.  And if the Chinese economy slows, they'll seek to export their way back to prosperity.

Of course, stay vigilant.  The economic slowdown in China is one of the major factors pushing down commodities prices.  It's possible that secondary and tertiary effects of the drop in commodities (and the currencies of commodities producing nations) could have unanticipated impact on Western financial institutions.  (Don't underestimate the potential for major banks to have unexpected exposures from derivatives positions and overly optimistic lending policies.)  But, thus far, China's financial isolation has largely protected the rest of the world from China's financial mistakes.

Monday, July 13, 2015

Is Greece No Longer a Risk?

In the last few days, the upstart government of Greece formed by Syriza Party leader Alexis Tsipras has completely reversed itself and signed up for a bailout from the EU that requires far more austerity than Greek voters rejected in a referendum just a week ago.  By all appearances, the EU rammed the ultra austere package down the throat of the Greek left-wing party, flattening Syriza's contentions like a tractor trailer rolling over a marshmallow.  We've had months of hand-wringing and teeth-gnashing over the dangers of a Grexit, and financial markets have shuddered every time Greece appeared to be heading out of the EU.  The EU's peremptory demands at the last minute might seem to have been a high-risk roll of the dice that somehow went in the EU's favor.  Or the EU knew that Greece had no leverage and made the Greeks take everything the EU wanted.

Considering how cautious the EU has been in the past, giving Greece two earlier bailouts totaling some $250 billion, it isn't probable the EU was bluffing in this round of talks.  That would likely mean it believes it has built a shield wall around its banking system that could withstand the consequences of a Grexit.  Stated otherwise, Grexit may no longer be thought to be a major risk to the European financial system. 

Even though the EU and Greece announced a "deal" today for a bailout, it's not at all a firm agreement, but rather a process for pursuing the possibility of more European assistance to Greece.  First, Greece has to adopt a number of austerity measures dictated by the EU.  Next, the parliaments of individual EU member nations have to approve further bailout talks.  Then, Greece will get interim financing that will keep it barely afloat while it and the EU yak for more months, maybe many more, to try to reach the final terms of a third bailout. 

There are many contingencies in this process, and it's quite possible the process won't lead to another bailout.  In that case, Grexit will follow.  But will it matter?  The EU seems to believe that Grexit wouldn't be a disaster, or it wouldn't have taken such a seemingly high risk negotiating position.  If it's right, then Greece will be mired for a long time in austerity and hard times one way or another.  And if the EU is wrong, then watch out, because a European financial crisis could lead to many, many bad consequences for a lot of people.

Monday, July 6, 2015

Ode To Greece's No Vote

Greek voters said "no" to the EU's latest bailout proposal, defiantly rebuffing another round of austerity. Democracy spoke, but the fat lady has yet to sing.  With a nod to Gilbert and Sullivan, this is how the song might go:

Here's a how-de-do.
If I vote for you,
When the time comes to make payments,
You will tell them we have ailments,
Default will ensue.
Here's a how-de-do,
Here's a how-de-do.

Here's a pretty mess.
In a month or less,
Greece will add some extra drama
By reviving the old drachma.
Banks will be distressted.
Here's a pretty mess,
Here's a pretty mess.

Greece's state of things
Is to life it barely clings.
Paying its debts with devotion
Doesn't seem to suit its notion.
More depression it brings.
Here's a state of things,
Here's a state of things.

No one knows what will be the result of this crisis.  Just remember that, no matter what, a good gyros makes for a fine meal.