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Why the U.S. is not part of the solution for global market volatility 26 Jan 2016

Recent global market volatility came to a head during the World Economic Forum, Davos 2016. On January 20th, stock markets around the world lost billions of dollars in bearish trades. The price of oil also fell below $27.00 a barrel. In the middle of these, some feared 2008-type market crash was upon us.

Policymakers and leading business leaders had headed to Davos, spooked by ‘weak’ economic growth data from China. But soon after their arrival, it became clear – thanks to Richard Quest’s Worry Wall -- that the world leaders arrived in Davos with little more than their worries, and in keeping up with an elitist tradition. The world is supposed to get used to a new normal of sub 7% Chinese economic growth rate, and low oil prices which signposted the road to Davos.

Those who believe low oil price is a problem were drowned by those who believe it is a problem they can live with. Low oil price itself is a zero-sum game. Net oil importers are enjoying lower energy cost, while oil exporters are earning less than 30% of what they earned per barrel of oil in 2014.

And so, Davos 2016 was a waste of time. It could not foster rallying points for rescuing the global economy that remains very fragile and under the spell of market volatility. Under this circumstance, the attention of the world was focused on an esoteric issue of the fourth industrial revolution. Man is in the process of creating a new world economic order in which machines and robots are going to displace human jobs.

It is obvious, then, that the economic problem in prospect is man-made. The helplessness at Davos 2016 was contrived by man. A conspiracy of actions and inactions is what is afflicting the global markets.

China was the key talking point at Davos for two reasons. One reason is the volatility that has emanated from Shanghai and Beijing, and reverberated in global markets. Should the transition in China’s real economy continue to unsettle its financial markets, it would impose substantial risk on the global market. There was a huge concern about that.

The other reason is whether China can continue to lift the world’s emerging economies and global markets like it had done in the most part of the last 20 years. China’s export manufacturing and economic growth were fuelled by commodities which it imported from the developing countries. This substantially stabilised many commodity exporting countries and accounted substantially for their economic growth. As China prospered, it also invested heavily abroad, helping to bolster asset prices.

China is now the world’s second-largest economy; it has yet to displace the United States as the largest economy in the world. But at Davos, the U.S. was hardly reckoned with in solving the twin problem of weak global growth and volatile global markets. Since the U.S. is not part of the solutions, it must be part of the problems.

The U.S. is rightly accused as being responsible for spurts of global volatilities, post the Global Financial Crisis. The interest rate hike which the Federal Reserve began in December was very much anticipated. This was not because of potential salutary effects or even its timeliness. It was an eventuality. Signalling it had for the last few years, and proving much more damaging recently, unsettled emerging and frontier markets.

At the expectation of monetary tightening by the Fed, emerging and frontier markets equities started to weaken on substantial sell offs. Simultaneously, the currencies of much of these markets came under pressure, in a scramble for dollars to exit these markets. The later stages of this also saw the precipitous crash in the price of crude oil.

If the U.S. policymakers felt they didn’t have much choice than to take economic decisions that were suitable for their local market condition – even if it imposes downside risks on non-U.S. equities, currencies and commodity markets – they can justify it. After all, at one level, they are exercising their economic policy sovereignty. At another level, the extraordinary monetary policy which the Fed have started to reverse had helped shore up asset prices around the world for at least five years.

However, the role the U.S. is playing in the crashing oil price has hardly been discussed or acknowledged. Four mutually reinforcing actions, overt or covert, makes the U.S. complicit in dragging down the price of oil. The first would derive from the decision of Saudi Arabia to squeeze U.S. shale oil producers out of the market. This is an extraordinary antagonism by one of the long-term allies of the U.S. The U.S. had for years been Saudi Arabian’s leading oil buyer. Access to Saudi oil and the wider oil from the Gulf States underpinned U.S. domestic energy security and foreign policy.

However, a combination of commercial development and geopolitical realignment have jolted the decades-old U.S. – Saudi diplomatic and trade relations. Both countries are now starring at each other to see who would blink first. Confident of its large oil reserves and how cheap it is to pump it into the international market, the Saudis believe they hold the aces over the more costly-to-produce shale oil. For this, the Saudis have rebuffed all entreaties on supply cut to shore up oil price. On its part, the U.S. rallied its Western allies to reach a nuclear deal with Iran. The Iranian nuclear deal has paved the way for Iran to return to the oil supply market, to further worsen the supply gut. But in geopolitical terms, Iran is now posed to be able to use its petrol dollars to further dilute the influence of Saudi Arabia in the volatile geopolitics of the Middle East.

Two, there has been the confrontation between Russia and the United States and its NATO allies. For Russia’s annexation of Crimea and for fomenting conflicts in Ukraine, the U.S. and its allies have imposed sanctions on Russia. While the Western media insist the sanctions were hurting Russia’s domestically, Russia fails to show any sign of weakness abroad. Instead, it decided a controversial intervention in Syria. However, Western leaders have continued to look for ways to make the sanctions which target Russia’s energy and finance sectors more effective.

Three, the U.S. recently lifted its embargo on the exportation of its crude oil. This, itself, is a nonevent; U.S. oil export would have no impact whatsoever on global oil supply. But lifting embargo on its oil export is symbolic of the downward pressure the U.S. is putting on oil prices.

Finally, U.S. bank, Goldman Sachs, has made the most sensational forecast of oil prices. It expects oil price to bottom out at $20.00 a barrel before a rebound. There is nothing scientific about how Goldman Sachs – who has many failed market predictions under its belt – came about this bottom price of crude oil. Contrary to Goldman’s downbeat forecast, the IMF while reversing downward its forecast of oil price for 2016 in its latest World Economic Outlook, sees oil at average $42.00 a barrel. This conveys something completely different from Goldman’s sinister $20.00 bottom price forecast.

Pundits have predicted policy divergence as the risks the world faces in 2016. While the U.S. Fed slowly and unsteadily continues to hike interest rates, the European Central Bank and Bank of Japan are expected to continue to keep interest rates in the zero lower bound. This suggests a misalignment in the global economic cycle – a complete misnomer in a much interconnected global economy. The supply glut may continue to explain the current low oil prices, but something more insidious is at the root of it. And the hoopla about China’s rebalancing is simply a decoy.