Global
Markets Slide
After China Sell-Off
By Nick Beams
01 March, 2007
World
Socialist Web
Global
stock markets tumbled on Tuesday after a near 9 percent drop in the
Chinese market—the biggest fall in a decade—sparked fears
that a series of financial imbalances in the global economy could start
to cause serious problems.
The global sell-off, which
hit all major markets, culminated in a drop of more than 415 points
on Wall Street or more than 3 percent. This was the biggest one-day
decline since the markets re-opened after the September 11, 2001 terrorist
attacks. At one point, the Dow was down by 545 points for the day, while
two other key indexes, the Standard & Poor’s 500 and the Nasdaq
Composite fell 3.5 percent and 3.9 percent respectively.
When trading opened on Wednesday,
the Australian stockmarket, highly sensitive to economic developments
in China, joined the global slide, falling by more than 3 percent and
wiping off about $45 billion in stock values.
The immediate cause for the
China slump appears to have been concerns that financial authorities
were about to take action to curb speculation, including a lift in interest
rates and a capital gains tax. The rumoured action has sparked fears
that riskier financial trades and investments around the world could
now be in danger.
“What we’re looking
at here is a big move away from risk,” David Durrant, a currency
analyst with a New York investment management firm, told Reuters. “The
big fall in Chinese stocks especially has got some people nervous about
the carry trade.”
The carry trade refers to
the process in which financial investors borrow money in one currency
at a low interest rate and then place it in high-risk assets in other
markets. This process causes what are considered distortions in currency
exchange rates. For example, while the Japanese currency should be strengthening
because of increased economic growth, the carry trade has seen a fall
in the value of the yen as investors transfer yen holdings elsewhere.
Large profits can be made
from these transactions but they depend on market stability. Once that
comes into question, with an event like the China sell-off, there can
be a rush for the exits.
Yesterday, International
Monetary Fund managing director, Rodrigo Rato, warned that carry trades
“could lead to more entrenched exchange rate misalignments that
worsen global imbalances.” Rato said the actual size of the carry
trade—estimated to be anywhere from $200 billion to $1 trillion—was
unknown, adding that there was no “simple solution” to the
problems. Financial markets and countries would be exposed if there
were a sudden unwinding of financial flows, he warned.
A number of other factors
appear to have fed into the Wall Street slide. According to figures
released by the US Commerce Department, orders placed with factories
for durable goods dropped by 7.8 percent in January, more than the predicted
decline, as excess inventories caused companies to limit spending. Orders
for business equipment experienced their biggest decline for three years.
The decline in durable goods
orders is another sign that the US gross domestic product (GDP) is slowing
and adds weight to predictions that the economy could move into a recession
later this year.
Speaking via satellite link
to a business conference in Hong Kong on Monday, former Federal Reserve
Bank chairman Alan Greenspan warned that there was a possibility of
recession by the end of 2007. The US economy had been expanding since
2001 and now there were signs that the cycle was coming to an end.
“When you get this
far away from a recession, invariably forces build up for the next recession
and indeed we are beginning to see that sign. For example in the US,
profit margins ... have begun to stabilise, which is an early sign we
are in the later stages of a cycle,” he said.
Tuesday’s slide—and
there could be more to come—will confirm the view of those economists
and analysts who have insisted that, while the world economy has been
growing, it is inherently unstable because of massive financial imbalances—above
all, the US balance of payments deficit. These critics have voiced concerns
that the continuous expansion of liquidity by the central banks has
given a distorted picture of actual risk levels.
In a comment published on
Monday, Morgan Stanley chief economist Stephen Roach warned that a “new
level of complacency” had set in. “It’s not just a
financial-market thing—extremely tight spreads on risky assets
and sharply reduced volatility in major equity and bond markets. It’s
also an outgrowth of the increasingly cavalier attitude of policy markets.
That’s true not only of central bankers but also .... [of] the
global authorities charged with managing the world’s financial
architecture. ... After four fat years, convictions are deep that nothing
can derail a Teflon-like global economy. That’s the time to worry
the most.”
Roach warned that an exceptionally
low level of nominal interest rates had fuelled “the great liquidity
binge that underpins an extraordinary degree of risk taking still evident
in world financial markets.”
In a conversation with Roach,
a former central banker had declared: “Who are we to judge the
state of the markets?” Reporting the remark, Roach said it was
indicative of a “very narrow perspective of the role and purpose
of central banking. Most importantly, it relegates financial stability
to a secondary consideration at precisely the time when financial globalisation
and innovation could be inherently destabilising.”
Whatever the immediate outcome
of the latest market turbulence, the events of yesterday are a reminder
of how rapidly the situation can turn in conditions where trillions
of dollars shift around the world every day.