Emerging Economies Starting to Wobble

The Chinese economy is weakening. Industrial production is falling. China’s exports fell by 8.9 per cent, year on year in July, compared with a 1 per cent fall in the first half of 2015. Investment in fixed assets is dropping. Household spending is down.

When vast amounts of credit allow economies to expand and use the resources of capital, labour and land in the economy to their fullest extent, this expansion of credit eventually creates its own reversal, as we know well here, and as the Chinese economy may learn in the coming months.
Chinese authorities are saying the equivalent of “it’ll be grand” to the Chinese people, and, perhaps, to themselves. To Irish readers, it should all sound a bit familiar.

The Chinese currency, the yuan, has been weakening over the last seven months, thanks to their domestic woes.

Just last week, the Chinese authorities built more flexibility into their exchange rate policies, causing a bit of a wobble on the markets, but nothing worth writing home about.

On August 11, by changing the way the yuan is valued, the authorities succeeded in devaluing the yuan by 1.9 per cent relative to the US dollar.

The stated ambition of the Chinese authorities for this devaluation was pretty simple. They argued the “market will play a bigger role in exchange rate determination to facilitate the balancing of international payments. Foreign exchange market development will be accelerated and foreign exchange products will be enriched”.

In other words, we’re going to let the market do its thing, with state involvement, of course, but fundamentally the price of the exchange of the Chinese currency will be more in the hands of the markets.

Weirdly, the bit of real news in last week’s devaluation is the flexibility the Chinese authorities now have in altering the exchange rate, relative to the dollar in particular. Everyone expects the yuan to be weaker in the coming months relative to the dollar.

Whatever its current domestic weaknesses might be, China is a major manufacturing and exporting powerhouse (and everything else actually) that needs a weaker currency to sustain its flagging economy. So the currency will, perforce, weaken.

Across the ‘emerging markets’, things are looking pretty grim. In addition to China slowing down, the biggest change is the collapse in the price of oil, which is changing the fortunes of many countries in the Middle East – they are effectively stopping production for the moment – as well as gas exporting countries across the globe.

Brent crude, used as the benchmark for half of the world’s oil, fell 1 per cent to $46.60 a barrel, pretty close to a six-year low.

The Saudi Arabian economy, for example, is getting whacked, as is the Russian economy. The rouble is doing the same thing as the Chinese yuan: trying to weaken in order to prop up export values and volumes.

Not everyone can devalue at the same time, though, and smaller economies are feeling the changes taking place in the ‘big beasts’ of the global economy.

For example, Ukraine’s sovereign bonds are falling before a Sunday payment deadline of about €500 million to its creditors it may well miss, precipitating either a partial default, a deferral or a debt restructuring deal.

Outside the eurozone, yes, debt restructuring is a thing. Expect Ukraine’s investors and Franklin Templeton, their advisers, to drive a hard bargain. But in the end they most likely won’t walk away with 100 cents on the dollar.

The Turkish stock market is taking a dive, while its sovereign bonds are trading at junk levels and deposits are flying out of the country – almost $4 billion this year – thanks to political stasis and the encroachment of Islamic State on its border to the south, as well as the general worry that the emerging market ‘market’ is about to turn on investors.

So people are selling off in markets such as Turkey, Ukraine and Kazakhstan, which followed China last Thursday, by changing its exchange rate to a free-floating one, rather than a peg, getting a 22 per cent fall in the Kazakh currency, the tenge, versus the dollar. Exporters in Kazakhstan are probably still high-fiving each other.

We often have a sense that the migrant crisis is somehow related to the conflicts taking place across Africa and the Middle East, but we tend to see the crisis in terms of effects on Europe and its borders.

The truth is much more complex, and is deeply related to the faltering fortunes of many of these economies, not least the conflict in Syria, the war in Donbass in Ukraine, the Southern Sudanese war, the Yemeni crisis, the Burundi conflict, the fighting in Somalia with Al-Shabaab, the violence in Nigeria and the encroachment of Islamic state in Libya.

Oil, China, competitive devaluations across the emerging markets while developed economies like Japan and the eurozone implement quantitative easing, a mass migrant exodus from the developing world, the eurozone stagnating economically while it builds walls to keep these migrants out – these are the broad contours of the world in late 2015.

The Irish economy, so small, so open, is exposed to all of these trends. We rise and fall with demand for our exports, and with the emerging markets wobbling, there’s a strong risk to our nascent recovery.

Not that Ireland’s recovery matters in the grand scheme of things. The global economy can do without us. But we are dependent on its fortunes.