Januarys market turmoil has very little to do with
China but a lot to do with the U.S. The trigger? U.S. interest
rates. The dollar is considered a safe haven and is widely
expected to rise further. Yet the currency is in a bubble and
may soon fall. The signal of when dollar weakness will start
will come from China.
We have in front of us an example of one of the most
interesting features of modern finance. Market participants
have different models of reality to explain events. When mass
adherence to a model switches, it can cause sudden market moves
crisis even. The dynamics of such a change in beliefs
have driven some of the largest moves ever in asset prices. A
key in guessing possible futures is to know what the different
views are and who holds them: mapping the structure of investor
bases but also the beliefs of different investor types.
There are two major global structural problems:
overindebtedness in the developed world and imbalances in the
international monetary system. These issues were at the root of
the 2008 financial crisis, and they have not yet been fixed.
The second problem helped cause the first: Asian savings pushed
down the U.S. yield curve and encouraged excessive borrowing.
This, on top of lax regulation, led to the 2008 crisis.
Because government intervention was not sufficient, the
Federal Reserve saw itself as the only institution between the
U.S. economy and full-on depression. A radical, untried program
quantitative easing was instigated to provide
liquidity to banks and push up asset prices so that banks could
recapitalize themselves. This action was taken to avoid
depression. But to admit as such may itself have caused
uncertainty and risked a depression. So central banks have made
a distinction between maximum and optimal transparency. They
are misleading markets deliberately. Markets havent fully
understood this yet.
One result of QE has been the large inventory cycle in the
U.S. Optimistic firms stock up, only to be disappointed. Hence,
we have seen a repeated pattern of healthy growth for a quarter
or two, followed by near-zero the next. The data do not
indicate strong U.S. recovery yet, although the judicious
choice of base time periods continues to fool many.
Quantitative easing may have prevented depression, but it did
not stimulate the U.S. economy. Consumer prices have remained