Investors around the globe are trying to decide if the dramatic selloff in China’s stock market reflects a severe downturn in the Chinese economy, the world’s second largest, with possibly dire consequences for the U.S. stock market and the U.S. economy.
The week began Monday with a dramatic 1,000 point drop in the Dow followed by a recovery Wednesday and Thursday, when the index registered the largest two-day point gain ever.
In the wake of unprecedented volatility in trading, many American households are ready to throw in the towel, bailing out of both stocks and bonds alike in numbers that are causing bank economists to wonder if the U.S. economy is about to repeat its 2008 dive into recession.
Nervous households flee to cash
Credit Suisse has found important evidence “mom and pop” middle America are leaving both the stock market and the bond market in numbers that have not been seen since 2008.
The bank noticed that in July and August retail investors that held nearly 90 percent of all U.S. mutual fund assets last year pulled money from both stock and bond funds for two consecutive months. It was a repeat of the fourth quarter of 2008, as the U.S. economy entered the financial collapse that brought on the recent deep recession, severely tarnishing President George W. Bush’s second term in office.
On Friday, Bloomberg Business reported Credit Suisse’s estimate that in July, $6.5 billion left equity mutual funds, just as $8.4 billion was pulled from bond funds.
Relying on data from the Investment Company Institute, the July outflows were followe in the first three weeks of August by investors withdrawing $1.6 billion from stock funds and $8.1 billion from bond funds.
“Withdrawals from equity funds are usually accompanied by an influx of money to bonds, and an exit from both at the same time suggests investors aren’t willing to take on risk in any form,” Bloomberg Business noted.
Typically, in stock market downturns, mutual fund investors go out of stock mutual funds and into bond funds.
But households across America are pulling cash out of both stock mutual funds and bond mutual funds, financial experts say, in an “investor revolt” against market volatility that may signal the beginning of a broad downturn in the economy.
Will Fed raise interest rates?
On Friday, the Federal Reserve’s No. 2 official, Vice Chairman Stanley Fischer, told CNBC the central bank has not decided yet whether or not to raise interest rates.
For the average American, increasing interest rates would first be noticed in an increase in the cost of borrowing. Adjustable Rate Mortgages, commonly known as ARMS, for example, would rise, increasing for many homeowners the amount of their monthly mortgage payments.
For the economy as a whole, increasing interest rates could precipitate an even deeper stock market selloff than that experienced in the last two-weeks, signaling an economic slowdown in which wages could be depressed even as jobs become harder to find.
Fischer indicated that until recently, “there was a pretty strong case” to raise the Fed’s benchmark short-term interest rate from near zero at the central bank’s policy meeting Sept. 16-17.
“The change in circumstances which began with the Chinese devaluation are still relatively new, and we are still watching how it unfolds,” Fischer said. “So I wouldn’t want to go ahead and decide right now what the case is [for rate increases], compelling or less compelling.”
What has drawn worldwide attention is the decision by the Chinese government to engage in a massive selloff of U.S. Treasury debt.
On Wednesday, WND reported that in the past two weeks, China has sold more than $100 billion in U.S. Treasuries, as much as it has sold in the entire first half of the year. China’s foreign reserve holdings in Treasuries were estimated at $1.27 trillion at the end of June.
On Thursday, Bloomberg Business confirmed that China has sold massive holdings of U.S. Treasuries this month directly, as well as through agents in Belgium and Switzerland. Beijing wants to raise the dollars needed to support the value of the yuan on foreign currency exchanges in the wake of a shock 3 percent devaluation on Aug. 11 that sent global stock markets into a massive selloff.
Ironically, China’s decision to sell U.S. Treasuries will trigger market forces that will force interest rates in the United States to rise, a phenomenon that might induce the Fed to hold off from raising the benchmark short-term rate at its mid-September policy meeting.
The widely read financial blog ZeroHedge.com noted on Friday that should China decide to liquidate its holdings of U.S. Treasury debt, the yield on 10-year Treasury bonds could increase by as much as 2 percent.
An increase in yields of that magnitude could force the Federal Reserve to begin a fourth round of “quantitative easing,” a policy in which the Fed buys Treasury debt to depress interest rates that would likely rise if the Treasury had been forced to sell U.S. government debt on the open market.