Don’t fear the black swan
Dark clouds have eclipsed the global economy once more. Equity and raw material markets across the world have turned volatile while bond prices are soaring as investors turn to safer government treasuries.
What’s going on? Is a black swan event the likes of the Lehman Brothers collapse six years ago in the making? The answer is no. Nothing fundamental has changed. No earth-shattering event is on the horizon. Investors are simply coming to grips with reality after premature and overly hyped expectations for a turnaround in the global economy earlier in the year.
Stock markets in some advanced economies sent some very wrong signals. The Dow Jones Industrial Average’s bullish run was way beyond sensible. It hit record highs throughout the year, reaching above a new milestone of 17,000 in September. The German benchmark stock index DAX also peaked above 10,000 in July. The Dow index has gained more than 150 percent over the last five years. A steady recovery in the U.S economy has led the Fed to start winding down its quantitative easing program and innovative enterprises are catching investors’ attention again, adding to vitality in the U.S. market. Still, the stock gains were excessive if you simply consider the fundamentals. Investors have come to realize that and the market has gone into correction, pure and simple.
The world economy was like a ship on a sea of liquidity pumped out on an unprecedented scale from central banks around the world. The ship stops in the middle of nowhere if the liquidity runs out. It doesn’t have enough power to run on its own. Concerns that the U.S. Fed would move to raise interest rates early next year after completing the tapering off of its bond purchase program appear to have been overblown.
Treasury and mortgage interest rates have also gained amid speculation of an earlier-than-expected U.S rate hike after the Fed completely ends its quantitative easing. The average rate for a 30-year fixed mortgage jumped to 4.5 percent early this year from the 3 percent range in 2012. Housing prices began to plateau and consumer spending sagged. The U.S bull run for stocks has been partly driven by better performances by companies, but also because of aggressive buyback programs. Companies issued corporate bonds using ultra low interest rates to finance repurchases of their own stocks. They will have to stop that now that interest rates have gone up.
The euro zone is in pitiful state. Economic growth has fallen to zero percent and deflation signs are everywhere. The European central bank may have to use the quantitative easing option now that it cannot push interest rates any lower. Japan isn’t in a much better situation. Its unlimited money printing and heavy fiscal spending have failed to sustain growth. The third arrow of Abenomics, structural reform to revive the Japanese economy never left its quiver. China has declared that it won’t aim for growth of more than 7 percent and instead will concentrate on strengthening fundamentals through stimulation of domestic demand and its services sector. Decline in demand by Chinese manufacturers and a super-strong U.S. dollar has sent international raw material prices nosediving. Emerging markets like Russia, Brazil and Indonesia, which thrive on raw material exports, have been hit hard.
In sum, there is little good news on the global economic front. But that shouldn’t be a surprise. The global economy has not fully recovered from the 2008 global financial meltdown. Investors prematurely popped the champagne corks. Now they’re suffering from a mighty hangover.
Volatile markets should not scare anyone. Corrections always follow spending binges. This has a silver lining: Investors will have more opportunity to invest when assets become more affordable. The economy is merely muddling along, for sure, but it won’t crumble or head for the abyss as it did in 2008. The problems are evident, and so are the prescriptions. But they will only work when the economy’s fundamentals improve. This could take time.
Luckily, Korean authorities have not entirely wasted the ammunition available to them. The central bank could resort to quantitative easing or money printing to buy back government bonds to stimulate the economy. That is a kind of monetization of national debt.
The Bank of Korea earlier this month cut the benchmark interest rate to 2.0 percent. Economists predict the base rate could be lowered to an all-time low of 1.75 percent early next year. Its powder is dry and it may need to use it someday. That’s how economies work, after all. What goes up must, eventually, come down.
JoongAng Sunday, Oct. 19, Page 19
*The author is the head of the Economist, a weekly business news magazine published by the JoongAng Ilbo, and the Korean edition of Forbes.
by Kim Kwang-ki