WASHINGTON – May be we should not try to read too much into the Dow Jones 1,000 points plunge at the opening on August 24. May be it is all about super fast electronic trading and other complicated technicalities. And, sure enough, the market recovered. Still, it is to remembered that this one-day collapse never happened before. I repeat: “never”. Besides, notwithstanding the relatively quick come back, the market was down almost 600 points at the close of trading.
Weak world economy
As we know, the US market’s rapid ascent was due in large measure to the unprecedented US Fed policy of zero interest rates that encouraged investors to put their money in stocks, not because the US economy is in particularly good shape, but simply because there is practically no alternative. Investors know this. They know that they are not on firm ground. And therefore they can be very skittish whenever something unusual happens. And the unusual is China’s sudden bad health.
No more fizz in emerging markets
Indeed, underneath the Wall Street lofty valuations, what we see is a relatively weak US economy that now will have to deal with a world engulfed in a full deflation originating in Asia. The rapid collapse of all commodity prices is a clear indication that the China-driven absurd level of demand for “everything” was not sustainable.
This means that several emerging markets whose ascent was largely led by growing exports of expensive raw materials to China now are confronted with slow growth or worse. Brazil is now in negative territory. Official forecast look at a 0.3% growth in 2016. Hardly inspiring. Therefore do not expect Brazil, Australia or Indonesia to help world growth. They are done. Likewise, the world’s big mining conglomerates are trying to survive.
At a different level, soft Chinese exports also mean lower demand for key components produced by South Korea, Thailand or Vietnam that go into the assembly of made in China products. Add these stagnating emerging countries to the drag on the world economy.
Likewise, major European exporters will sell less to China. From luxury goods to BMWs, a slow-growing Chinese economy means soft demand for imported consumer goods.
US doing barely OK
So, where does all this leave the US? Not in a particularly good place. Granted, the knee-jerk Wall Street reaction to the latest Shanghai stock exchange plunge was overdone. Overall, the US economy is not that dependent on business with China. We sell mostly agricultural products to China, and that is likely to continue. The Chinese still need to eat.
However, we do a lot of business with the rest of the world. The fact that Japan, South Korea and Germany are directly affected by China’s slow down matters to us.
Dumping and deflation
And there is more. China will try its best to dump abroad its mountains of excess manufactured or semi-finished products in practically any sector. Therefore, we can expect that America will be hit by exports of super cheap Chinese steel, solar panels, and almost everything else. This will hurt many US companies that will be unable to compete with under priced Chinese imports. This wave of dumped imports will force US corporations to lower their prices. Some of them will go out of business, with consequent loss of jobs. (See above about deflation).
Besides, many of the large US multinationals, from GE to Caterpillar to United Technologies, now get most of their revenue from sales abroad. However, growth strategies based on increased foreign sales will have to be revised. Stagnating or declining foreign economies in Asia, Latin America and Europe cannot absorb more US products.
The impact of collapsed oil prices
Here at home, we have to deal with the consequences of collapsed oil prices. (WTI is now under $ 39 per barrel). While there is some benefit down the line for American consumers, this is a disaster for the entire energy sector and a seriously bad development for the broader US economy. Soon enough, North Dakota, Texas, Oklahoma and other states will feel the impact of new unemployment or under employment among oil workers, engineers, geologists, pipe and drills suppliers, and many others. Expect additional ripple effects on local real estate prices, restaurants, shopping malls, and a lot more.
Are we on the brink of disaster? No, we are not. However our fragile growth is threatened by weak fundamentals, (in part hidden by the impact of Fed policies on stock prices), and a weakening global economy.
The Dow Jones 1,000 point drop was a freakish event. But it did happen. This is a reminder that when investors know that they are holding a lot of stocks whose market value is not determined by a solid economy, they are ready to dump them, the entire lot, at the first sign of big trouble. And, by the way, the rebound from minus 1,000 is not that strong. On August 24, the day of the collapse, the Dow Jones closed down 588 points. Of course, in the days and weeks ahead all this can change. Still, this is not what I would call a display of investors’ confidence.