“Financial crisis come in all shapes and sizes” says John Plender, writing in today’s FT, “Yet looking back over the past 100 years from the vantage point of today’s credit squeeze, the big financial dislocations appear to follow the same pattern.”
And according to Plender’s pattern, we can expect a crash in China.
Plender gives us three examples to consider; the crash of 1929, Black Monday in 1987 and the credit crunch.
The backcloth has invariably been a shift in global power whereby the growth of an immature creditor country wedded to protectionist trade policy has contributed to imbalances of savings and investment. Attempts to manage the currency volatility arising from imbalances have derailed monetary policy and created bubbles in asset markets, leading to crashes and financial distress.
In 1929, it was Britain and the US. Britain ran a high trade deficit, permitting the high-saving, protectionist-inclined US to run a big trade surplus. Add to this scenario the political desire to artificially manipulate a flagging benchmark -the British pound and the gold standard:
The impetus for the stock market euphoria of the 1920s came partly from a loose monetary policy pursued by an inexperienced Federal Reserve in a misguided attempt to help the British preserve the value of the pound after the return to the gold standard. As so often, when efforts are made to manipulate an external price, the exchange rate, instability was simply transferred to internal prices – in this case prices of equities.
And in 1929, the bubble burst. Then consider the 1980s, when the US and Japan were the main protagonists. This time the US was running the high deficit, fuelled by an overvalued dollar. That was allowed by Japan, an instinctively protectionist creditor country. Add to that scenario the desire to artificially manipulate a benchmark – the dollar:
The main financial event was taking place in Japan where official intervention to stabilise the dollar was having the same impact as the Fed’s intervention to prop up sterling in 1927. As with the 1929 Crash, it was the central bank’s decision in 1989 to raise rates that pricked the bubble and set the scene for more than a decade-worth of economic stagnation.
Here’s a spooky graph:
Which brings us to the present day: a US trade deficit fuelled by the vast accumulation of dollar reserves in Asia. Add to that, a sliding US dollar – and a political desire to keep it “strong”, and an undervalued renminbi creating a liquidity bubble in China.
How does the credit crunch fit into all that? It’s a symptom of the problem, rather than it’s conclusion: a hiccough in a huge global recycling of liquidity that is the markets’ response to huge imbalances.
But that means the bubble hasn’t yet burst. As long as such huge deficits and surpluses are allowed to exist, and currencies are kept at artificial levels, we’re still swelling the problem.
The question, says Plender, is whether governments wake up and start being flexible, or whether they cling to currency valuations the market is undercutting.
China is still at an early stage of development, it may be a case of many bubbles and many crashes. The only question is whether the impact is felt globally, as in 1929, or mainly domestically, as with Japan in the 1990s. The longer policy remains inflexible, the greater the likelihood of a global backwash.