Three stimulus stars are rising

Amid great nervousness, markets are betting on a coincidence of stimulus measures from Europe, the US and China. But central banks may have a tough time delivering as much investors expect.

Fasten your belts for more bad news from China but increasing pressure for a triple-headed global stimulus – an event not seen since the global financial crisis in 2009.

Yesterday I learned that a heavy equipment supplier to China was experiencing an order decline in the vicinity of 50 per cent. That means less steel will be required, so iron ore and metallurgical coal prices could fall further. Already China steel and iron ore prices have fallen to levels not seen since 2009.

BHP Billiton‘s China antenna has picked up the major China slowdown, which caused chief executive Marius Kloppers last week to sound a commodity price alarm (Kloppers predicts more commodity price falls, August 26).

According to The Wall Street Journal, China Construction Bank Corp, the country's second-largest lender, is warning of increased credit risks from the bank’s rising non-performing loans in eastern China.

The bank is experiencing a sharp rise in defaults from borrowers in the Yangtze River Delta, which is a major hub for small manufacturers and exporters.

For Australia, if these developments continue, it means that the local budget surplus, which was always a figment of the government’s imagination, will be officially declared impossible. Australian interest rates will fall.

But the pressures building on the global stage are far more important than the local repercussions.

The global stock markets believe that the further declines in China, the European crisis and the slow US recovery will each trigger a massive response from central banks and, in the case of China, the government. Although there is great nervousness, markets are holding because enough people believe the stimulatory stars are in the ascendency and will lead markets to much higher levels. The danger is that the underlying problems are so deep that the central banks will not be able deliver what the markets expect. Nevertheless China can’t afford growth to fall too far because are people losing jobs, which will have social and political implications.

In Europe, if, on September 6, the European Central Bank President Mario Draghi gives another half-baked stimulus package, markets will be under significant pressure. But markets are confident he will not make that mistake because of the alliance between the European Central Bank and Italian President Mario Monti.

Accordingly, market people expect that on September 6 Draghi will announce that his ECB will buy sufficient European bonds to keep a cap on borrowing costs of Spain and Italy.

The Bundesbank will protest wildly and if it blocks Draghi then markets will be devastated. But German Chancellor Angela Merkel no longer has the same clout because unless she agrees, Monti is threatening to take Italy out of the euro and use the lower lira to enable Italian industry (which now has better industrial relations laws) to devastate Germany. (Monti, Draghi and the Goldman pact, August 20 and German-Italian clash pushing down rates August 21).

There is no time to lose because in Spain, Catalonia (the province that houses Barcelona) can’t raise money and is turning to the Spanish government, which can’t help without the ECB (How do you say 'bailout' in Spanish? August 29).

If Draghi does not deliver, or delivers half-heartedly, then brace for big market falls. But there is a lot of money on the sidelines looking to invest if Draghi delivers and the Bundesbank is sidelined.

Meanwhile in the US tomorrow, the annual Jackson Hole meeting called by Federal Reserve chief Ben Bernanke takes place.

While his speech in the same spot two years ago effectively heralded QE2, it's expected by most that this time he'll be laying the thematic groundwork for QE3 or further stimulatory measures, should the Fed find the need to use them. The market wants him to make QE3 almost a certainty. Again, the markets will be very disappointed if the Bernanke does not point to QE3.

The prospect of Europe, the US and China all taking to the money printing presses at the same time is probably too much for market people to hope for – two out of three may be fine. But if we get the three stars rising then speculative buying for shares and commodities will rise sharply. But the long-term problems will still be there.