(This post originally was submitted to a subscription-only financial investment site. I have included it here on my blog in order to reach a wider audience.)
The first two weeks of 2016 have proven that the global economy being so reliant on China can wreak havoc on the stock markets of all the major indexes in the world. The uncertainty which is pervading Wall Street regarding the future of the Chinese economy and their currency is the underpinning for the rapidly declining performance of the US financial markets.
The second issue with the global economy is the precipitous drop off in the price of oil. The price for a barrel of crude oil is now down to below $30.00 and this huge price decrease on a commodity as vital as oil is great for consumers paying less at the pump to fill their cars, but it is detrimental to the overall economic outlook.
The rationale behind the drop in oil prices is tied to two main factors. First, it is a matter of basic supply and demand: the world has too much oil and far less demand for this resource. The United States alone has contributed to this situation with the abundance of laws clearing the way for the rise in hydraulic fracturing, or fracking, in huge swaths of land called shales or shale plays. The result of fracking created conditions in the market where oil was entering the system from several new entry points in different states that previously did not contribute to the oil supply. This added to the increasing supply quantities.
The second component to the drop in oil prices is the decreasing demand from emerging economies in other parts of the world including, and most importantly, the Chinese economy. The slowing growth of manufacturing and other factors in China have a chain reaction effect where the world’s largest emerging market needs less oil.
In addition, a factor that is certainly contributing this issue and will continue to be in the coming months is the freedom of Iran from economic sanctions and their subsequent reentry into the oil market. The broader issue is that Iran has not made any money from their oil supply due to the international sanctions levied because of their nuclear program; so any revenue it makes from the sale of oil is gravy to them. This will translate into a commodity pricing battle between Iran, Saudi Arabia, Libya, Iraq, and other Middle Eastern countries who are in dire need of liquid cash so they have turned on the oil faucet, so to speak.
The evidence of the impact of these new Middle Eastern players (Libya, Iran, and Iraq) is demonstrated by the dip in oil prices below the $30.00 threshold. Many economists will attribute this to an overabundance of supply of oil because a couple of reputable studies show that American demand has not diminished and that Americans are driving more now on average than in the past several years.
The root cause of the issue revolving around a global economy that is reliant on China is that the accounting practices in that Asian powerhouse have been consistently under scrutiny for being unreliable in the best case scenario. This inherent unreliability coupled with inconsistent practices in quality control as well as variability in their supply chain all equals what Wall Street cannot handle: unpredictability.
That unpredictability coupled with the turbulent valuations surrounding the Chinese currency, the yuan, and the result is the wild swings in the trading activity across all the major stock indices from the start of 2016. The data coming out of China, financial or otherwise, is so completely unreliable and lacks so much credibility that the integrity of the entire financial marketplace is vulnerable to the deficits we have witnessed in the first two weeks of this year.
Some economists and financial market analysts will tell you that China is a growing economy with an emerging middle class which was bound to hit some “bumps in the road” and that this was expected. My take is slightly different in that I do not think our entire global economic future should be underpinned by the performance (or lack thereof) in China. I know it may seem naïve but I feel like it must change, it is a fundamental flaw in the global system.
Other economists and experts predict that it is precisely because of this widespread reliance on China and products manufactured and exported from there all over the world, that the global system will collapse worse than it did in 2008. In that case, if the first two weeks of this New Year are any indication, we might be in for that situation playing out exactly in that manner.
The other notion that is prevalent in some circles of the financial realm at this point is the thought process that the Chinese yuan might be trying to elbow its way into the top currency spot in the world.
I find even the mention of this so fraught with concerns because of all the issues with the currency valuation in China at this point. The recent decline in the overall growth of the Chinese economy will have a reverse effect in that I believe it will drive investors back to the American economy and to invest in the US dollar. The US dollar is, and will remain, the top currency in the world based on the stability of our democracy and our economy, even in the event of a recession or a downturn.
It is time for us as investors and for the world economies involved to look at China with caution and to prepare your portfolio strategy accordingly for both the short term and the long term investment objectives. In the end, this year is showing us what most of us already knew, we cannot trust the information coming out of China and we need to embrace different practices when evaluating their economy in the future.