Why China sent the global markets spiraling
A stunning sell-off in China rippled across Europe and triggered a frenzy on Wall Street. At the closing bell, American traders cheered, glad that the day was over. Judy Woodruff discusses the recent global market volatility with David Lampton of Johns Hopkins University and Mohamed El-Erian of Allianz.
JUDY WOODRUFF: As we reported, the markets plunged early today and late. Investors were on a wild ride, not just here, but globally. Trillions of dollars of value have been wiped out in the past few weeks.
The swings of this day, like several others, started in Asia.
It began with a stunning sell-off in China, where the main financial index plunged 8.5 percent.
WOMAN (through interpreter): How can markets drop everyday like this? What we earned is all taken away by the markets.
JUDY WOODRUFF: The rout rippled across Europe, sending the French and German markets down about 5 percent. And from there:
MAN: The Dow is — the Dow is down 1,000 points.
JUDY WOODRUFF: The opening bell on Wall Street triggered a frenzy of selling.
MAN: I don’t — this is — I got to make some phone calls.
JUDY WOODRUFF: The market spent the next hours clawing its way back, as the White House urged calm.
JOSH EARNEST, White House Press Secretary: What I would encourage people to evaluate is the ongoing strength and resilience of the U.S. economy.
JUDY WOODRUFF: In the end, though, the losses deepened again. The Dow is now down almost 11 percent so far this year.
Let’s try to get some further intelligence and analysis into what’s happening and why the markets are so volatile of late.
Mohamed El-Erian is chief economic adviser at Allianz. It’s a multinational financial services company. He’s a columnist for Bloomberg View. And David Lampton is director of the China studies program at Johns Hopkins University’s School of Advanced International Studies.
And we welcome you both.
Mohamed El-Erian, let me start with you.
So the Dow was down 1,000 last week, another almost 600 today. What is driving this?
MOHAMED EL-ERIAN, Bloomberg View: Two things.
The market is trying to get to terms with, first, lower global growth, particularly out of emerging markets and China. And, second, the market is worried the central banks have run out of ammunition. So put these two things together, and then investors are repricing the market lower.
Once you start moving lower, then you trigger of all sorts of things. You trigger people who have to sell because they’re over-levered. So they sell their winners and their losers. They’re just trying to raise cash. So, what you then get is spreading malaise throughout the global markets. And that’s what we’re seeing right now, Judy.
JUDY WOODRUFF: But, Mohamed El-Erian, staying with you, haven’t investors known for some time that China’s economy was in trouble? Haven’t they had time to get prepared for this?
MOHAMED EL-ERIAN: You always think that markets will get prepared, but people like staying in the trade. Why?
Because, for years, now, we have been able to sustain asset prices well above fundamentals, because central banks have been the markets’ best friends. So markets have started to rely on central banks always coming in.
This shock is different. It’s not something out of Greece and Europe, where the European Central Bank can intervene. It’s not concerns about the Fed or the U.S. economy. It’s concerns about emerging markets, and, therefore, investors have less faith that the central banks of the U.S. and Europe are going to be able to intervene.
JUDY WOODRUFF: So, David Lampton, let’s talk about what’s going on in China. We have been watching ups and downs over there. What is happening? People are used to seeing the government of China control everything. What’s happened now?
DAVID LAMPTON, Johns Hopkins University: Well, I think you have got a number of things.
First of all, the Chinese market has had an almost unbelievable year, and it’s gone up 130 percent on one exchange, 170 on another, over 200 percent on another. And so, common sense, ultimately, is going to prevail. Pricing-earning ratios are anywhere from 32 to 80, where they might be 13 to 16 in the U.S.
So I think the Chinese market was just unbelievably overpriced. Secondly, bad numbers started coming into the Chinese. Exports and imports dropped 8 percent in July. This not only panicked Chinese exporters and people in the import business, but also all of China is the biggest trade partner for many countries in Asia.
So I think China has pricked the bubble. Also, I think there is something very fundamental going on politically. And that is all the news over the last couple of years with the new leader, Xi Jinping, has been about how strong he is, how much he’s like the kind of power that Mao and Deng Xiaoping had in the system.
JUDY WOODRUFF: Right.
DAVID LAMPTON: And I think people are now beginning to see that governing China in the 21st century is different than 40 years ago, when reform — and I think they’re beginning to ask, how capable is this leadership with dealing with a much more integrated, interdependent economy?
And so part of this, I think, is a reduction in — somewhat in confidence in the leadership.
JUDY WOODRUFF: Well, Mohamed El-Erian, if that’s the kind of uncertainty — if there’s that sort of uncertainty about what’s happened in China and what the leadership is capable of, what does that mean investors should think? Does that mean we’re going to see even more volatility in the days to come?
MOHAMED EL-ERIAN: We are certainly going to see more volatility, because the market has to adjust to a new paradigm, a new reality, and it’s doing this with less liquidity.
So, the reason why have got these wild swings you referred to this morning, during the day, Judy, just to give you a context, we traveled back and forth 5,000 points on the Dow. That’s an enormous distance to travel in one day.
And the reason why, there isn’t enough liquidity. So, every time a buyer comes in, you rally. Then some sellers come in, you go the other way, and I think that type of volatility is going to continue for a while, until the market finds its footing.
JUDY WOODRUFF: And what does that say, though, or does it say something about the underlying strength of the U.S. economy?
MOHAMED EL-ERIAN: So the biggest threat — and I think it’s a risk scenario, not a baseline — is that the spillover from weak global growth to the market then spills back to the U.S. Why?
Because people get more cautious, they worry about their 401(k), they spend less. So, that’s the big risk. I don’t think it’s going to happen just yet, but the U.S. has to cope with a slower global economy. We are going to be selling less goods to China and to other American countries.
It’s not just China, Judy. It’s China, it’s Brazil, it’s Indonesia, it’s Turkey, it’s Russia. There is a generalized slowdown in the emerging world.
JUDY WOODRUFF: Well, to the extent China is a factor here, Dave Lampton, how are we to understand that? Who’s pulling the strings? Who is making decisions? What should we be looking for out of China?
DAVID LAMPTON: Well, I think one of the problems is, is the current leader, Xi Jinping, has actually centralized policy to a rather extensive degree.
And whereas before, when we wondered what was going on in the Chinese economy, we might talk to Zhu Rongji, who was the premier, there were people to talk to in the system. We had confidence. Now he’s put in a new team. We’re not entirely sure who many of these people are. In the economic realm, we know more of the actors than in the political realm.
But in general, I would say the Chinese leadership is less transparent, we have less confidence how they’re making the decisions, and their initial response to the dramatic fall last week in the stock market was really quite reversion back to the kind of planned economy measures you would see.
So they seemed to have an impulse towards reform, but when things get tough, they fall back on the more planned economy, non-market features that they have. So non-transparency and inconsistent policy, I would say, is the fundamental problem.
JUDY WOODRUFF: If that’s the case in China, Mohamed El-Erian, how are investors everywhere to read that?
MOHAMED EL-ERIAN: So, they worry about corporate profits. They worry about the ability of companies to continue to buy back their stock, and they reprice the market.
And this is an issue, Judy, that is related to the fundamental aspect, which is, for years, now, markets have been valued well above what’s warranted by fundamentals. And by that, I mean what’s warranted by the ability of the global economy to grow.
Prices have been up here. The economic conditions have been down here, and the difference has been the liquidity injected by central banks. And now we’re getting a convergence of prices back to what would be validated by economic conditions.
JUDY WOODRUFF: Speaking of central banks, I can’t let you go, Mohamed El-Erian, without asking you. There has been all this expectation that the Federal Reserve is going to raise interest rates starting in September. How does all this affect that?
MOHAMED EL-ERIAN: I think it means that it’s very unlikely that the Fed will raise interest rates in September.
It’s a very big risk to take right now to fuel financial instability further. So they will wait. By December, there will be clarity on one of two things. Has this financial instability really impacted consumer spending and, therefore, caused a headwind to the economy? Or, alternatively, let’s not forget that part of the sell-off is in the commodity complex.
It’s pushing interest rates lower on government deals. So the other side of this is that the economy benefits from lower oil prices and lower interest rates. So the December question is still on the table because of these competing forces on the U.S. economy, but I think, for September, it is highly unlikely that the Fed will raise interest rates.
JUDY WOODRUFF: All right, and, quickly, David Lampton, are you looking for stability to come in China or the other…
DAVID LAMPTON: I think, on this day of such volatility, it’s wise to remind ourselves that there still there are some very positive fundamentals in the Chinese economy.
They have another 300 million people urbanized. And wages are going up. And people are getting employed. And so the Chinese economy hasn’t had a meltdown as severe as today’s numbers might suggest.
JUDY WOODRUFF: So, keep looking for those positive signs?
DAVID LAMPTON: Yes.
JUDY WOODRUFF: David Lampton, Mohamed El-Erian, we thank you both.