In Cernobbio it is the Chinese crisis the greatest fear among the entrepreneurs meeting behind closed doors on the first day of Ambrosetti workshops. Indeed, the slowdown of the Dragon worries 36,2% of the participants questioned in an impromptu poll during the work of the Forum. 25,2% are more concerned about the slowdown in some emerging markets. If the Russian-Ukraine crisis puts 15,8% on alert, Isis and Islamic Fundamentalism, the Middle East crisis and the migrant emergency each stop below 10%.
Jacob A. Frenkel, president of JP Morgan Chase International, and former governor of the Bank of Israel, the Chinese crisis is a correction due to a precise choice of the Beijing government and the collapse of the markets should not be dramatized, indeed in some cases it may be desirable.
FIRSTonline – Mr Frenkel, what do you think of the Chinese crisis?
FRENKEL – Development in China has created many challenges. The first comes from the slowdown in the real economy; the second from the financial sector which has suffered a sharp fall in the stock market and which is a separate challenge from the first even if it is connected to it. China has grown at a spectacular rate for many years, but the growth model was unbalanced, it was export-led, the engine was exports, and in many cases it caused international tensions. It was an unsustainable model because it relied too much on foreign demand and with many vulnerabilities. Too much reliance had to be placed on commodity-producing countries to buy the raw materials needed for production. China has decided, because it was a decision, to change the growth model and to shift it towards domestic demand, to shift it from manufacturing to services. A choice that in the long run will be positive but that in the short term causes tension. Now China imports fewer commodities from the rest of the world and this is negatively transmitted to emerging markets. Because of this we have seen the decline in commodity prices. If one thinks that in the long term this change is positive, the cost of the transition must be interpreted as an adjustment cost and not as a crisis. But even the commodity-producing countries must learn to have a much more diversified economy. They are aware of it but they are certainly not happy about it. The direction is clear.
FIRSTonline – So can we still bet on Beijing's strength?
FRENKEL – In 3-4 years China will do much better than commodity producers. The reason why China will still be a giant in the medium term is the demographics and urbanization of still a large population who live in the countryside and who will move towards the cities. This is the engine of growth. Size matters.
FIRSTonline – What about the financial sector?
FRENKEL – The second challenge comes from the financial sector which is experiencing a massive correction that has occurred in stages. We originally came from an exaggerated rise in the stock market, completely unreasonable, China's p/e had gotten too high and was out of alignment with the rest of the world. Growing profits was tricky, so prices went down. As the economy began a transformation towards services, it was the energy and cement sectors that collapsed. Many of the listed stocks were from these sectors. This has created panic and the government has tried to counter it but has not been successful. So the first phase of the correction involved an adjustment that was not fully understood.
FIRSTonline – And then what happened?
FRENKEL – The second phase, after the misunderstood adjustment, is precisely that of panic. Which has spread internationally. I personally believe this process is a correction, clearly a move into new territory, but one that needs to be addressed. However, it must be kept in mind that the Chinese stock market is not the mirror of the Chinese economy. The Chinese economy is much larger and more diverse than the financial market. We should understand that corrections even if painful in some cases are not undesirable. And governments should mitigate them but not try to oppose them massively.
FIRSTonline – What to expect on the Fed rate front?
FRENKEL – The Fed itself has announced that it wants to normalize the interest rate situation and that it will do so in a sequence of very small, measured steps so as not to shake the system. It will start when it is convinced that the normal conditions are in place: growth, the labor market and inflation. On all three fronts the Fed is very close to normal conditions.
And the data published today (yesterday's Ed.) do not change the scenario. I don't think it's interesting to know if it will be in September, October or November. In two years, normalization will be underway. We must not exaggerate the drama if it will be September or October. I believe that after a few days of confusion, the Fed's decision will be seen as positive by the market because it means that the Fed sees growth as robust.
FIRSTonline – Some believe that the Chinese government's recent moves on the yuan are more related to future Fed tightening than to the growth issue.
FRENKEL – No one is talking about a dramatic rate hike, we are talking about a maximum of 0,25 basis points at a time. So this could not have justified the move on the yuan, it's a matter of orders of magnitude, there is no correspondence between the two moves. China's currency decision is more related to the growth theme and the financial sector. China aspires to an internationally important yuan. If you want a currency to be global you have to allow it to be driven by market forces. China has decided to allow greater flexibility but has had to adjust the shot and there have been stop and go that have increased the uncertainty. But don't worry, it's part of the fix.
