Embrace a Huge August Shock
Yopie Hidayat (Contributor)
USUALLY, the financial markets of emerging economies get anxiety attacks in August. That is how the track record repeating year after year. Huge shocks happen because the value of transactions grow thin as many investment managers go on summer vacations. In such a shallow market, a small issue can cause drastic price movements. The market becomes more prone to volatility.
The problem is, this year is not a usual one. The signs indicate that not only will the August episodes of past years be repeated, this time the shocks will be even greater. It is not just for emerging markets, the coming August shock will hit developed economies as well. The global economy is facing a serious threat.
The most important factor that making that threat bigger and wider is of course the Covid-19 pandemic. On top of that, the trade war between the United States and China is actually intensifying while the pandemic is still escalating. There are signs that the US and China will be locked in a conflict that goes beyond business and technological rivalries and more akin to Cold War. Both countries have given political sanctions, closed consulates, and engaged in mutual intimidation through battleship deployments in the South China Sea.
The most recent indicator that market volatility will ramp up this month is the damage on the US economy at the end of Q2 2020. Annualized, the US economy contracted by 32.9 percent, its worst showing since World War II. The shock to the US economy will certainly have global effects. The US is still the world’s biggest economy and one of its main locomotives.
The US economy still contracted severely despite The Federal Reserve’s all-out efforts to protect it. Unlimited liquidity injections have been given, amounting to trillions of dollars. But in reality, that extraordinary attempt is still unable to prevent the economy from collapsing due to the pandemic. The US dollar is slowly slipping away. At the end of June, the dollar has lost 9.14 percent against the main world currencies since its highest point on March. Investors are going back to gold as a safe haven in times of crisis, making its price rise to nearly US$2,000 per troy ounce.
The worsening US economy and the fall of dollar has shaken market confidence. Goldman Sachs, one of the biggest financial institutions in the world, is now shining a spotlight on the US dollar as the currency for global foreign reserves. Goldman’s strategy experts gave a reminder that it is not impossible for the US to lose that privilege. The US dollars is sufferring from a serious currency debasement problem. The Fed has printed massive amounts of dollars to fund recovery efforts for the US economy. Just since the virus outbreak, the Fed has printed US$2.8 trillion.
Goldman Sachs’s concern still remains a footnote and not a consensus in the financial market. However, that dire warning should not be ignored. There is still another factor: US political issues heating up in the election year. This will also add to negative sentiments that already existed.
Politics has caused a rift in US government policy regarding Covid-19 response and economic recovery. One example is the US$600 weekly handout for the unemployed that ends in July. The Republican Party wants to shave that benefit off to US$200 per week starting on August. On the other side, the Democratic Party wants the US$600 to keep going until January because it helps the economy keep rolling.
In normal conditions, the market is used to political mayhem in the US Congress. Even when dead ends forced various US government institutions to shut down several times, the market remained calm. But a policy stalemate is another matter when the economy is in its death throes.
Investors around the world ought to be worried at economic developments in the US. If the political deadlock ultimately results in a suboptimal compromise, the victim will be the US economy, and it will absolutely drag the rest of the world down with it.