Investors took a wild ride this week at the rodeo that is the Chinese stock market. The more important horseback riding, however, is that of the central bankers who, in between macroeconomics lectures, don cowboy hats at the Federal Reserve’s annual retreat in Jackson Hole, Wyoming.
Worries that China is reining in its ultralax lending policy led to wild gyrations in the Shanghai share index, which dropped 5-6 per cent on Monday and Wednesday but was then back up by more than 6 per cent by week’s end. Markets around the world followed the swings, prompting chatter about whether Chinese equities will now lead stock markets with which they are historically uncorrelated.
This is quite possible, as market psychology is capable of believing just about anything. It is also insignificant. The Chinese equity market is small, shallow and anomalous in tracking government lending rather than guiding private capital allocation. And even in mature markets stock prices are at best a limited reflection of how the underlying economy is doing.
That is why this year’s gathering in Jackson Hole is more important than anything happening on stock markets. Central bankers have a good claim to having broken the world economy’s fall. Contractions slowed almost everywhere in the last quarter; Germany, France and Japan returned to growth.
The race for the recovery is starting in earnest. Monetary policy works with a delay, so it is only now we are beginning to see the full effects of central banks’ savage interest rate slashing.
The same is true of fiscal policy. Some governments were unduly hesitant to spur on their flagging economies with deficit spending. But others cracked the whip vigorously and the bulk of that stimulus will hit their economies (and the free-riders who export to them) over the next several quarters.
That Beijing also adopted such policies has been good for China but will not play a big role in the global recovery: China’s economy is too small. Its profound, long-term effects on the world economy notwithstanding, the reins are still firmly in the rich countries’ hands.
Their central banks must not slow the acceleration we can now expect. But they should plan carefully which route to take at the next crossroads. As fiscal stimulus tapers off, demand will be volatile. Step too hard on the brakes and the economy could again nosedive.
This will be tough – a bit, as it were, like tightrope walking on horseback. Central bankers are not riding into the sunset quite yet.
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