If you’re like me, you’ve been curious about all the news regarding stocks, global markets, and commodities but you don’t really know what’s going on. I don’t claim to be a financial expert by any means (and I frankly don’t want to be), but I would like to find out just what is happening to U.S. and global stock exchanges and what it means for the average person. I’ve taken the liberty of breaking down what the current world economic situation is, where it’s likely to go, and what that means for you.
There’s No Simple Story, But it Begins with China
Probably the hardest thing to swallow about the volatile markets is that there is no one factor that I or anyone can point to and say “Look! There’s the cause of our problems!” There are so many factors that play into something as large as the global economy that boiling the problem down to a simple story isn’t just naive, it’s impossible. However, every story has a beginning, and in this case it’s China. As the second largest economy by gross domestic product, China pulls a lot of weight in the global economy. So growth rates that are missing estimates combined with growing pains as the domestic economy transitions from industrial and manufacturing to high technology and white collar industries have triggered concerns about how strong the Chinese economy actually is. One of the concerns, a “38 percent drop in the Shanghai composite index since June 12”, as NYT writer Neil Irwin writes, even as millions of newer middle class Chinese citizens invest in the stock market. What’s more, government efforts to stop the downturn, including cutting interest rates to record lows, billions in stock buybacks, and suspensions on new share listings seem to have no effect. If private and public efforts can’t put the brakes on the downturn, then what can? What does this mean for the rest of the world?
Enter the next character: Oil
As a consumer who has to buy gas for his car, the fall in oil prices is definitely a good thing. However, for the larger world economic climate, the fall is definitely a bad thing. It’s especially bad because oil supply, which should decrease as the price of oil falls (Macroeconomics anyone?) has actually held steady, creating a surplus and driving prices down further. Crude oil trading at about $44 dollars a barrel as of September 14th wouldn’t be a bad thing if not for the fact that every economy in the world uses the commodity. And remember China? Well the economic slowdown the country is experiencing also reduces demand for basic raw materials and commodities, oil included. Lower demand from China and other emerging markets combined with high supplies leads to even lower prices. Lower prices in turn hurt huge oil producing markets in the Middle East and Latin America where there is little to be done about stemming the flow of oil. It’s one big cycle that’s hurting everyone involved as long as it continues. So we have oil and China, anything else?
Here Comes The Fed
The United States Federal Reserve is the final main character in the story and its role, while seemingly harmless, has big impact for the global economy. Essentially, the Federal Reserve (the Fed) is the central bank of the United States, tasked with determining monetary policy, banking regulations, and interest rates, among other tasks. The big question in the coming weeks if not days will be if the Fed will raise the federal funds rate (the interest rate at which banks borrow money from the Fed) or continue holding off on the rate hike until sometime after this recent market volatility. The Fed has been signaling an increase in interest rates for some time, gauging the health of the U.S. and the world economy as having recovered enough from the Great Recession to handle such an increase. At the same time, raising rates in this current climate, with China struggling and oil prices creating massive problems for developed and emerging economies alike, is likely to negate all the work the Fed has done in pumping money like crazy into the U.S. economy (the Fed has two ideas on how to raise rates post-Great Recession, ” ‘One of which is a system for paying banks not to be as aggressive in their lending, and the other is a system for paying non-banks, other kinds of financial firms, to also be more cautious.’”)
The Grand Finale
So what is the takeaway and what do you need to be worried about? For starters, we can only hope that the fears and paranoia surrounding China either disappear or at least come down to earth. Every modern economy that started out as an industrial or manufacturing powerhouse has transitioned to an economy of services and high technology, something that China is clearly not immune to as it goes through its own transition. There will still be growing pains but if the United States can do it, so can China. So for the average American, there isn’t much to be concerned about (at least initially).
Oil prices staying low bode well for the consumer (i.e. you) but could have larger ramifications if the supply stays at current levels and demand remains low. Moreover, many analysts agree that the supply in oil has hit bottom already, and as oil companies usually over-react to these types of supply and demand situations (and most already have by “slashing their 2015 exploration budgets” says Catherine Hetrick, senior analyst at InvesTech Research), we could see supply leveling off with demand in as little as six months. China and other emerging/transitioning markets play the other role in this idea, as they are the primary drivers of demand. Again, as long as you enjoy low gasoline prices, you should be ok.
Finally, the Fed has probably the biggest impact on you and the markets. If they raise interest rates, borrowing becomes more expensive, so everything from student loans to housing loans become more expensive for us. Moreover, companies will be affected too, having to pay more on the capital they need for financing business ventures. This, in turn, affects global stock markets. While I can’t boil the cause of the current market volatility to one item, I can produce a simple equation: China+Oil+Fed = economic headache.
Samson Cassel Nucci