Global Economy: China's Casino Moment - by Holger Schmieding

First boom, now bust: The Chinese equity market may soon serve as a standard case of what can go wrong in the financial sphere.

But seen from afar, do we have to worry? Not much, at least not about China. The Chinese equity market does not have much to do with the real economy. It plays no major role in financing Chinese investment.
China’s equity market is also not a leading indicator for the country’s business cycle. It follows its own dynamics driven by liquidity, regulation and the usual panics and manias to which young financial markets are even more prone than established ones.

The 150% surge which the Shanghai Composite Index registered from mid-2014 to its peak on June 12, 2015 did not lead to a major surge in business investment and Chinese GDP growth.

The fact that the market erased roughly half of these gains until yesterday will not herald a major decline in Chinese investment. However, there will be some impact on corners of the private sector — especially on consumption of luxury goods.

Read more: China's Casino Moment - The Globalist

Capital Markets: In Praise of Fragmentation - by Adair Turner:

Emerging markets are back in the spotlight. Investors and banks are suddenly unwilling to finance current-account deficits with short-term debt. South Africa, for example, has had to increase interest rates, despite slow economic growth, to attract the funding it needs. Turkey’s rate increase has been dramatic. For these and other emerging countries, 2014 may prove to be a turbulent year.

If volatility becomes extreme, some countries may consider imposing constraints on capital outflows, which the International Monetary Fund now agrees might be useful in specific circumstances. But the fundamental question is how to manage the impact of short-term capital inflows.

Until recently, economic orthodoxy considered that question invalid. Financial liberalization was lauded because it enabled capital to flow to where it would be used most productively, increasing national and global growth.

But empirical support for the benefits of capital-account liberalization is weak. The most successful development stories in economic history – Japan and South Korea – featured significant domestic financial repression and capital controls, which accompanied several decades of rapid growth.

Likewise, most cross-country studies have found no evidence that capital-account liberalization is good for growth. As the economist Jagdish Bhagwati pointed out 16 years ago in his article “The Capital Myth,” there are fundamental differences between trade in widgets and trade in dollars. The case for liberalizing trade in goods and services is strong; the case for complete capital-account liberalization is not.

One reason is that many modern financial flows do not play the useful role in capital allocation that economic theory assumes. Before World War I, capital flowed in one direction: from rich countries with excess savings, such as the United Kingdom, to countries like Australia or Argentina, whose investment needs exceeded domestic savings.

But in today’s world, net capital flows are often from relatively poor countries to rich countries. Huge two-way gross capital flows are driven by transient changes in perception, with carry-trade opportunities (borrowing in low-yielding currencies to finance lending in high-yielding ones) replacing long-term capital investment. Moreover, capital inflows frequently finance consumption or unsustainable real-estate booms.

And yet, despite the growing evidence to the contrary, the assumption that all capital flows are beneficial has proved remarkably resilient. That reflects the power not only of vested interests but also of established ideas. Empirical falsification of a prevailing orthodoxy is disturbing. Even economists who find no evidence that capital-account liberalization boosts growth often feel obliged to stress that “further analysis” might at last reveal the benefits that free-market theory suggests must exist.

It is time to stop looking for these non-existent benefits, and to distinguish among different categories of capital flows. Some are valuable, but some are potentially harmful.

Foreign direct investment (FDI), for example, can aid growth, because it is long term, involves investment in the real economy, and is often accompanied by technology or skill transfers. Equity portfolio investment may involve price volatility as ownership positions change, but at least it implies a permanent commitment of capital to a business enterprise. Long-term debt finance of real capital investment can play a useful role as well.

By contrast, short-term capital flows, particularly if provided by banks that are themselves relying on short-term funding, can create instability risks, while bringing few benefits.

Read more: Adair Turner: In Praise of Fragmentation

Global Economy Turmoil: Emerging Mix Rattles Nervous Markets - by Richard Barley

A trouble shared is a trouble halved, or so the saying goes. But the troubles are piling up quickly for emerging markets.

Jitters about China, the meltdown in the Turkish lira, violent protests in Ukraine and the plummeting Argentine peso—underlaid with continuing nerves about the withdrawal of U.S. monetary stimulus—have all combined to hit risk appetite. The problems aren't particularly new and don't have much in common, but the combination is proving toxic.

The biggest repercussions have been in the foreign-exchange markets, where even currencies of countries with relative fundamental strengths, such as the Polish zloty and the Mexican peso, have started to show signs of strain. Pressures have also emerged in asset classes that have so far remained resilient, such as U.S.-dollar-denominated emerging-market bonds. That will understandably make investors nervous.

But some of the concerns may ease. China is seeking to shift from an economy led by investment to one driven by consumption. This is such a vast and complex process that worries about how it is progressing will be with us for a long time yet. The small dip in China's manufacturing purchasing managers index that some cite as a key reason for the market turmoil seems just a pretext.

Ukraine and Argentina both look worrying, but their impact on global financial markets should be limited. If other Latin American or Eastern European currencies get hit, but are supported by relatively strong economies, that could make them look good value in time.

Turkey bears watching closely. The solution to the continuing selloff in the Turkish lira—which Friday hit a fresh record low of 2.33 to the dollar—seems clear: the Central Bank of Turkey needs to raise interest rates. But political turmoil means it is unwilling to do so; its interventions in support of the lira are inadequate in the meantime.

This could cause larger problems. Turkish companies have large foreign-debt exposures, and the lira's slide could cause balance-sheet strains. That suggests that the central bank will ultimately have to hike rates to avoid a bigger crisis. But the situation could get much more uncomfortable before that happens.

Meanwhile, the risk aversion in developed markets smacks of using the situation to exit some very popular and profitable bets. Southern European government bonds and stocks, hybrid securities that blend features of equity and debt and subordinated bank bonds have all had a strong start to the year; but they are also volatile. No wonder investors might take the chance to step back.

Read more: Heard on the Street: Emerging Mix Rattles Nervous Markets - WSJ.com

Qatar: Canada won’t budge on environment, Peter Kent insists - by Shawn McCartey

Environment Minister Peter Kent arrives at the United Nations climate summit in Qatar this weekend with a target on his back, representing the only government that has withdrawn from the Kyoto Protocol and taken a hard line on the need for emerging-market countries to make binding commitments to reduce greenhouse-gas emissions.

In an interview before leaving Ottawa, Mr. Kent made it clear that Canada would not deviate from its contentious path or sacrifice economic growth to cut emissions. “We are taking our obligations seriously,” he said. “But we are balancing our obligation and engagement on climate change with sensitivities to the realities of Canada’s still-recovering economy, job creation and job growth, and we will continue on that course.”

Global environment ministers and leaders arrive in Doha for the second week of a conference that aims to reinvigorate flagging international commitment to the battle against climate change, even as many developed countries struggle to emerge from economic crises.

In the run-up to the meeting, UN officials have been warning that the world is running out of time to take the action needed to avoid catastrophic climate change, and new studies show that polar and Greenland ice masses are melting and sea levels rising more quickly than had previously been expected.

Read more: Canada won’t budge on environment, Peter Kent insists - The Globe and Mail

Norway euro 457.134 bn wealth fund to cut European exposure

Norway's euro 457.134 (US $610 billion) sovereign wealth fund, Europe's biggest equity investor, plans to sharply reduce its European exposure while raising investments in emerging markets and Asia-Pacific, the finance ministry said on Friday.

Of its entire bond, fixed income and real estate portfolio, European investments will be "gradually" reduced to 41 percent from 54 percent, while Asia-Pacific's share will rise to 19 percent from 11 percent, Finance Minister Sigbjoern Johnsen told a news conference. "We're reducing our European exposure because we see that economic development in the global economy is changing and this should also be reflected in our investment strategy," Johnsen said. "Most likely we'll have to sell some assets in Europe."

As a result, the share of emerging markets in the fund's total portfolio will rise to 10 percent from 6 percent and the share of the Americas and Africa will rise to 40 percent from 35 percent.
"It is just not possible to say how long this will take, it should be gradual and taking into account market circumstances," ministry State Secretary Hilde Singsaas said.

For more: Norway $610bn wealth fund to cut Europe exposure