The world economy will slow down

Once again, stock markets prove to be good (perhaps even the best) discounting mechanisms we know, predicting the direction of economic circumstances to come. Almost everywhere they are crumbling, and it’s not hard to figure out what’s going on. 
The Chinese and Indian markets are perhaps symptomatic. These are some of the worst performing markets in the world, you wouldn’t notice that these happen to be in the two big growth stories of which it was (until recently) argued that their growth would hardly be affected by the subprime and financial crisis in the US.

Could one ever be serious about this ‘decoupling’ theory? It was just that, a theory. Now, these economies are under attack from a series of forces:

  • The American slowdown is especially threatening for Chinese export machine, notwithstanding the fact that China embarked on a policy to be less dependent on foreign, and more on domestic markets
  • Inflation is unleashed in the whole world, and in the runnaway growth that still exist in China, this will eat up purchasing power. One example, China is now paying almost double the even recent price for iron ore going into it’s big steel factories. We only have to mention energy prices, and the recent hike of the (managed) energy prices in China, and you’ll get the picture
  • Rising energy prices have increased shipping cost more than 50% from last year, throwing more sand in the wheels of the great Chinese export machine
  • In order to combat this inflation, central banks everywhere are hiking interest rates; Brazil, South Korea, India, etc., even China is tightening monetary conditions, increasing mandatory bank reserve requirements.

Can this not have an effect on the world economy? China might very well be losing competitiveness already, as it’s demand switching policies have allowed wages to increase at 15%, further boosting inflation, and although managed, but it’s currency is also on an inexorable path upwards, eroding price competition from two sides.

And, Chinese markets peaked last year and are already more than 50% below their top. Indian markets are also way down, losing 30% this year. Is this all going to end? Yes, of course, when the discounting is done. The funny fact is that there are surprisingly little signs of a major downturn in the real figures.

Economic growth in the US was still positive in Q1, and the Chinese and Indian economies have shown little signs of any, let alone a major reduction in economic growth. Little doubt this is going to happen though. Adjustments in the financial markets just happens to be so much faster.

Not only do financial markets move much faster, they also have a tendency to overreact. It’s called overshooting, things have to become so cheap in order to generate expectations that prices will rise again.

With the sharp correction in many of the emerging market exchanges already underway, we could very well get the following picture; rising stock exchanges while real economies start to deteriorate in earnest. As long as the latter remains within expectations, this becomes a real scenario.

Are we there yet. We’re afraid not.