The party is over.
This morning, for the first time in its history, the Dow Jones Industrial Average dropped 1,100 points, a free fall not seen in US markets since the 2008 financial crisis. As of this writing, the Dow has recouped more than half its losses, down “only” two percent, but the future today and this week is far from certain. Global markets slid by more than four percent in Europe and Asia, in a day filled with financial carnage.
Tuning into CNBC or other financial channels, you hear a lot about the technicals of the market; 200-day rolling averages and a slew of other insider statistics and comparisons that make little sense to outsiders. On a day like today, this is about as useful as counting the pieces of broken pottery after an earthquake; it gives measure to the damage, but not to the cause.
It’s time to face facts.
Since 2009, the global economy has grown – tepidly, unevenly and sporadically – almost solely based on the largesse of central banks in the US, the EU, Japan and China. These central banks released unprecedented amounts of capital into the market to prevent the worst excesses of the 2008 crash, and provide a cushion for the private market to recover.
Central banks pushed interest rates down to near zero while national governments approved trillions in economic stimulus. The US spent nearly $800 billion. China, with a GDP roughly 60 percent of the US level, spent about the same amount on its domestic stimulus. The EU pushed massive stimulus to save the countries on the southern rim, caught in the sovereign debt crisis.
But the original purpose of the largesse, to provide a temporary cushion until the private market could again regain its balance, never actually occurred. The financial spigots were never really shut off, as the underlying economies never really recovered as recoveries have been understood since the end of WWII. In a manner of speaking, growth in the last six years has not been organic, but rather borrowed, fueled by monies pumped into the economy through the central banks or sovereign governments.
This has been reflected most obviously in the stock market.
The Dow, which fell nearly 50 percent between October 2007 and March 2009 in the simultaneous collapse of the housing and stock markets, was up more than 150 percent as of July 2015.
There is no underlying economic logic to this rise. While the country has improved from the immediate aftermath of the ’08 crisis, and returned to growth in the second half of 2009, that growth has been barely adequate compared to previous recoveries. Official unemployment is now near “full employment,” yet 95 million Americans are not in the workforce. Wage growth has been stagnant. The number of Americans on public assistance is the largest since the Great Depression.
But none of this has deterred the stock market from soaring, where central bank activism has replaced economic fundamentals as the metric for asset growth. Bad GDP numbers, a spike in unemployment or a collapse in factory orders? No problem! That just ensured that the Fed was going to continue to prime the pump and keep interest rates at zero, pushing money in to the market and driving up prices.
Let’s have a party!
And central banks are complicit. In the absence of a better policy, it was hoped that an improving stock market would have the psychological effect of improving confidence and thus triggering organic economic growth that would eventually allow the central banks to taper off their stimulus and raise rates to historically “normal” levels.
That never materialized.
But sooner or later, central banks would have done all that could be done, leaving markets to deal with the harsh realities of actual economic fundamentals.
That is where we are today.
Before last week, the hand writing was on the wall. US growth in the first half of the year is a weak 1.4 percent. Industrial production, corporate profits and personal income are down. Wages are flat. Factory orders are up 3/10ths of one percent for all of 2015. In the EU, Germany grew 0.4 percent in QII. Italy grew by 0.2 percent. France did not grow at all. The aggregate of the entire EU was just 1.3 percent. The Russian economy has contracted sharply in the last two quarters. Brazil is experiencing negative growth, and the Japanese were in negative territory for QII.
That left China.
And the bottom is falling out of China.
This should have been telegraphed by the price of oil, which has dropped precipitously in 2014-15. But happy financial warriors insisted that the oil glut was a result of higher production, not falling demand, and stocks continued their march on the belief that lower fuel prices would spark consumer spending. That simply wasn’t true.
China, which once had years of double-digit growth, has struggled to meet a government target of seven percent expansion. In August, after unusual volatility in the Shanghai exchange, which has fallen 38 percent since June, it was announced that Chinese exports were down eight percent for July, with decreasing factory orders and a double-digit down turn in construction.
The cascade began from there.
China represents 15 percent of global output.
In recent years, the run up in commodities has been fueled almost exclusively by China’s need for oil, gas and minerals to feed its expanding industries. Commodities suppliers expanded accordingly. Now there is excess capacity and not nearly enough demand. The collapse in commodity prices is the result.
Chinese communist party leaders, believing that they can control capitalism, have been slapped harshly by reality as traditional fixes – devaluing their currency, driving stimulus spending into the economy – have only served to unnerve international currency markets and prop up wasteful and risky state-run enterprises. The Chinese problem is not temporary and conditional – it is chronic and structural.
The world woke up this morning to realize that trillions have been wasted, propping up an unsustainable – artificial – economic model, and that as of today, there are no authentic engines of economic growth in the world. Global stock markets, which have been fueled by that artificial growth, are only now beginning to adjust to the reality.
Expect more pain before things get better.