Catching a chill when the Chinese dragon blows cold

Opinion Piece by Brian Hayes MEP published in the Irish Independent on Tuesday 1st September 2015

It has been a turbulent time on the international stock markets. The recent collapse of Chinese stock markets has roiled investors around the world. The collapse of Chinese stocks is not a surprise. What is surprising is why the Chinese authorities allowed such a massive bubble to develop during the previous 12 months when Chinese stock markets increased by a staggering 150pc.

During the recent recession, it was Chinese investment and growth that saved the world from a deep depression. While the rest of the world was stagnating, China continued to grow by an average rate of 10pc per annum, sucking imports from all over the world and growing its own share of world export markets.

China is now the second-largest economy in the world and contributes 15pc of world GDP and 25pc of all exports. The transformation of the Chinese economy and society during the last 35 years has been on a truly epic scale. The rate and pace of change in China in recent decades is unprecedented in human history.

But no large economy can continue to grow at a rate of 10pc indefinitely. China has also been attempting a very difficult task of rebalancing its economy towards a more sustainable model, where the individual consumers will play a more central role. The wider risk for China is the danger that an economic slowdown may lead to political tensions. Change on the scale China has experienced must create enormous social pressures.

The response of all the major economies to the recession has been a dramatic reduction in interest rates and large-scale quantitative easing (QE) by central banks. These measures are not risk-free. In fact, there is an argument that QE is a form of market manipulation because part of its intended purpose is to drive down long-term interest rates.

The historically low levels of interest rates and the very low returns on secure government bonds make it extremely difficult, if not impossible, for pension funds to adequately provide for future pension demands. Many pension funds across the developed world now find themselves under-provisioned. The current very low level of returns from traditionally secure investments is increasing the danger of pension and investment funds moving into more risky assets. Ordinary savers are also big losers when interest-rate repression is used as a deliberate economic policy.

Economist Richard C Koo has pointed out that when individuals and companies are focused on paying down debt, low interest rates and QE may not be a stimulus to investment. They may have unforeseen, negative consequences.

In recent years, very low interest rates and QE have become something of a drug in the financial world. It is very easy to become dependent on drugs, even prescribed drugs; giving up is much more difficult . Returning the world to more normal monetary conditions will not be easy and has the potential to precipitate other financial crises.

In the short term, the Irish economy and Irish consumers may benefit from a world slowdown. This is most obviously so in terms of energy prices. However, Ireland is an extremely open economy, highly dependent on the export of goods and services. A slowdown in China of itself will have a small direct impact on Ireland.

A slowdown in economies heavily dependent on China, such as the US and many European economies, will have a negative impact on Ireland. After a period of very favourable exchange rates against sterling and the dollar, the euro has begun to strengthen in recent weeks, which is not to Ireland’s benefit.

This week, the CSO quarterly household survey published very strong jobs figures. In the year to the second quarter 2015, employment increased by 57,000, nearly all of them full-time jobs. In the first half of 2015, just over 34,000 jobs were added to the economy. More than 1,000 people are going back to work each week. The recovery is broad-based, with nearly all sectors of the economy showing jobs growth.

However, complacency is not an option. Government finances, while much improved, are still finely balanced. The national debt remains at a dangerously high level. The Fiscal Advisory Council is correct in its analysis that the Irish economy is particularly vulnerable to external shocks.

More than any other eurozone country, our economy is truly international. We gain more than most on the upside, but on the downside we are exposed more than other countries.

The prudent, measured approach that brought this country from the brink of disaster to a sustainable recovery must be maintained. Prudent capital investment, a continuing focus on jobs, modest expansion in spending and modest reductions in taxes will help keep the country on a strong growth path.

As the countdown to the general election begins, politicians across the political spectrum must resist the temptation to return to auction politics which brought this country to its knees. China’s difficulties right now might just be a good thing in the long term, in highlighting the need for prudence on the home front.

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