Expect fallout from desperate measures in desperate times

Which is the greater global threat: Grexit or China? With Greece's exit from the eurozone apparently averted after premier Alexis Tsipras accepted the terms of a third bailout, and China's stockmarket on the rebound from a rapid 32% fall following the intervention of the Chinese authorities, you might think the question is now redundant.

Indeed, before answering this question - posed in a briefing note issued before the deal with Greece was done and also before Chinese shares had started to rise steadily - Julian Jessop, chief global economist at Capital Economics, stated "that neither actually has to be a big deal".

Too complacent

At the time it appeared that global investors pretty much agreed with this assessment. Sure, there had been some volatility in US and European financial markets in the weeks up to 10 July, just before the twin issues were seemingly resolved, but a 5-10% fall in equities is not unusual in the summer months.

However, I worry that markets have been far too complacent in their reaction to these critical market events. At the time, Jessop was right to say neither had to be a big deal.

But I suspect historians will come to judge the events of the weekend of 11-12 July, when Greece's creditors tightened the screws on the leftist Syriza-led coalition, far more harshly than they view the methods adopted to stem the sell-off in China.

Nevertheless, the measures taken by China's Communist party to halt a rout that wiped around $3 trillion (£1.9 trillion) off mainland-listed 'A' shares - a fall of a 32% in little more than a month - smacked of desperation. Half of the market's listed companies suspended trading.

Short-sellers attempting to "destabilise" the market were threatened with arrest. Corporate stakeholders were prevented from selling their shares. Local mutual funds were "encouraged" to buy, not sell, and state-owned banks reportedly spent $200 billion buying shares. Negative phrases in official market reports were banned.

For now, these actions have proved effective, and the sell-off, which was indiscriminate, likely created some bargains for fund managers such as Dale Nicholls, manager of the Fidelity China Special Situations investment trust.

In an exclusive View of the Day, Nicholls also points out that the Chinese policy response "on the whole has been disappointing and in many ways runs contrary to the spirit of broader reforms and general market liberalisation".

Although this episode highlights how state interference can influence the price of shares that are listed in Shanghai or Shenzhen, it is not particularly surprising, and for foreign investors who have bought into mainland-listed shares, such interference was probably something of a relief.

Moreover, even at the market's nadir the Shanghai exchange was 80% up over a year, so many investors are still sitting pretty. Remember, too, that when the Shanghai index sank from above 6000 to below 2000 in 2007-08 (it is currently trading at 3824), the real economy continued to grow.

The moment of truth

Jessop reckoned that, given other supportive statistics, there is only a small chance of a hard landing in the real economy being triggered by a sharp fall in Chinese equities. So you can probably tell what Jessop's answer to the greater global threat - Grexit or China - was.

But when he wrote that "neither has to be a big deal", Jessop was writing five days after Greek voters had decidedly rejected the terms of an expired bailout in what has been dubbed the "Oxi" referendum, and three days before EU president Donald Tusk fatuously announced the "aGreekment" between Greece and its creditors.

However, it has become a big deal. As we now know, Germany's finance minister Wolfgang Schäuble suggested a "temporary" Grexit of five years, and had the bailout not been agreed at the political equivalent of one minute to midnight, that might have been the outcome of the negotiations.

When devising the terms of the bailout, the Troika (European Central Bank [ECB], International Monetary Fund [IMF] and European Commission) chose to punish Greece and worsen the parlous social, political and economic situation.

The terms have been widely condemned as unnecessarily severe, politically toxic, economically suicidal, and a humanitarian disaster for a large swathe of its people.

Even the IMF, which belatedly released the findings of its "debt sustainability analysis" after the deal had been sealed, now seems reluctant to participate in the five-year, up to €86 billion (£60 billion) bailout, because the deal does not acknowledge the requirement for some form of debt restructuring.

So, with IMF participation not guaranteed, a Greek electorate that is seething with anger at the bailout terms, and infighting within the governing party likely to lead to fresh elections in the autumn, the five-year bailout will not get far off the starting blocks before stumbling.

Since the first signs that a deal was in the offing, European markets have risen strongly (the FTSEurofirst 300 index is up 9%) - but they are also rising on the magic carpet of ECB quantitative easing. Although the latter is supportive, I don't see this confidence lasting too long.

First, markets have ignored the fact that Germany nearly forced a member of the eurozone to leave the supposedly unbreakable currency union, which sets a precedent for others to leave as well (perhaps it will eventually be Germany itself).

Second, I predict the demands made of Greece by Germany and other eurozone "hawks" will, in a short space of time, prove unworkable, even if the IMF agrees to participate. Jessop himself was prescient when he stated that "the economics of Greece's position make an eventual exit from the euro highly likely. The politics may simply determine the timing".

Politics will time Grexit

It seems clear to me that "the politics" has merely delayed the logical outcome of what Schäuble has advocated privately since 2012, and is now arguing quite publicly - that Greece does not have a place in the eurozone unless it is permanently in thrall to northern European economic hegemony.

For quite different reasons I believe Greece should seek a way out. The country can never be economically competitive within the currency union, and staying within it means endless austerity, open-ended promises to consider debt restructuring (as in the last bailout in 2012), and further falls in living standards.

Grexit is a solution that, if carefully managed, ultimately offers Greece an escape from its life sentence in a eurozone debtor's prison.

The bailout agreement has been signed, but certainly not delivered. The answer to Jessop's question has not changed since he posed it, and that is why I expect the relief rally in European markets to prove shortlived. And his conclusion on which event was the greater threat?

"Even though China's economy is much more important than that of Greece alone, the combination of the higher probability of Grexit and the risks of contagion mean that developments in Europe may yet pose the greater threat. Indeed, we expect the eurozone economy to slow again next year, undermining global growth, whereas we think the bulk of the deceleration in China is now over."

Investors should walk into China's stockmarkets with their eyes wide open and a long investment time horizon. More importantly, though, they should be wary of sirens calling an end to the eurozone crisis and position themselves for further market volatility, particularly in Europe, in the months ahead.