Predicting that China’s economy is heading towards a stock market crash, reaching that unfortunate destination in 2016, is certainly risky. It may even be presumptuous and premature to suggest the notion of China’s economy falling to pieces.
But the Chinese government’s defensive moves to support stock prices and the economy, by combining expansionary fiscal policy with an expansionary monetary policy, suggest that Beijing is worried about an approaching market collapse in 2016.
On August 25th, for the fifth time since last November, China cut the interest rate on loans by 0.25%, setting it to 4.6% among other steps linked to the release of $23.4 billion into the economy through repurchase of securities (REPO).
This achieved the desired effect of lowering the yuan against the dollar by 4.7% in an effort to boost Chinese exports—such as steel and solar panels—against fierce competition with the U.S. for international markets. In fact, all emerging countries’ currencies, with the exception of the Indian rupee, have been devalued against the dollar.
China’s Stock Market Crash Foreshadows Economic Collapse in 2016
The Shanghai Composite Index lost 8.5%; wasting away all gains made since the beginning of 2015. It was as if the clock had turned back eight months in a matter of a few hours. Nevertheless, the data is more dramatic, showing a significant retreat. China has seen the lowest growth rates since the 1990s; the Caixin manufacturing index has reached the lowest level of the past six and a half years, all of which has forced the government into taking drastic currency devaluation maneuvers.
Chart courtesy of www.StockCharts.com
Rather than taking Mao’s famous “giant leap forward,” the Chinese have taken a corresponding leap backward, time traveling to the period before the spectacular growth of the early 2000s. The recovery measures have managed to control the economy’s rate of descent, but an analysis of some basic economic indicators suggests it will take a very skilled combat pilot to stave off a crash. President Xi Jinping is certainly skilled and wise. But even in a centrally controlled economy, he lacks sufficient controls to make a soft landing in the face of the wild capitalist headwinds that China must confront to avoid a stock market crash and economic collapse.
Meanwhile, this delicate phase of transition for the Chinese economy has unearthed deep tensions in the stock market. The Shanghai Stock Exchange lost about 60% of its value in a period of two months. The rate of loss was staggering: 22% four sessions alone in early September, wiping out any gains made in 2015. It should be noted that the same exchange has gained 40% over the past 12 months.
Beijing’s measures taken in response to an evident display of fear prompt the question of just what the state of the Chinese economy is. Does the devaluation point to a one-time, however violent, adjustment? Or does it conceal a deep crisis?
Excluding gold, China has an estimated $3.8 trillion in foreign currency reserves as of December 2014. China’s gold reserves were 1,658 metric tons, which is about a fifth what the U.S. holds. However, gold has seen a sharp price drop over the past two or three years from its peak of $1,921/oz. to $1,135 per ounce, corresponding to a value of $61.0 billion.
The international private banks have read the writing on China’s Wall, responding with downgraded growth rate predictions. Goldman Sachs cut forecasts on the growth of China over the next three years, displaying its own pessimism about the second-largest economy in the world’s bill of health. Last Monday, the bank lowered its growth domestic product (GDP) forecasts for 2016, 2017 and 2018 respectively to 6.4%, 6.1%, and 5.8% from already bearish estimates of 6.7%, 6.5%, and 6.2%.
Chinese Government Still Hoping for 7% Growth This Year
Goldman Sachs’ pessimism is just the latest sign of the storms that will loom over China’s economy over the next few years. The yuan devaluation has frightened investors worldwide and pointed to the weakness of earlier measures to ease investors’ concerns. Eventually, Chinese authorities will be forced to heed reality and concede to taking down their growth projections and ambitions by several notches.
Goldman Sachs’s growth projections are based on the three factors of labor, capital, and productivity. In China’s case, each of these three components is expected to slow. Even if we take the Chinese government’s 6.8% growth projections at face value, it still points to a significant slowdown compared to last year when the economy grew by 7.4%. At best, the economy is facing increased uncertainty and economic policy, because this is how Beijing has chosen to interpret the numbers.
Source: World Bank
Goldman has a harsher interpretation, pointing to extreme volatility in equity markets and, more recently, the devaluation of the CNY, which have increased the uncertainty about the dynamics of the exchange rate in the future. The bank warned that it will only be a couple of months before the “uncertainty will affect the Chinese economy,” exposing its fears of economic collapse and a stock market crash.
The Chinese dragon is about to fall. Moreover, when a dragon falls, it does so making a big noise and spreading its flames and poisons all over the place with its last breath. China has essentially embarked on a structural transformation that could take decades to unfold as it confronts the classic capitalist economic problem of overproduction. Accordingly, China will try to sustain the so-called real economy (particularly exports) after a series of disappointing macroeconomic data, hoping to achieve this through its devaluation.
Another less-popular explanation is that China is trying to make the yuan more amenable to the standards of international finance as expected by the International Monetary Fund (IMF) to gain access to the latter institution’s so-called Special Drawing Rights (SDR). However, even in the best of circumstances, the IMF hinted that it would only grant China SDR privileges no earlier than in September 2016.
Economist Andy Rothman, a keen observer of Chinese markets, stresses, “China is a continental economy, driven by domestic investment and domestic consumption, where exports play only a supporting role.” This suggests that any export decline, even a pronounced one, would have some negative consequences, but not enough to break the economy. (Source: China is Not Export-Driven, June 19, 2014.)
Indeed, China’s trade accounted for four percent of GDP in 2010 (in a peak the economic growth period). This is considerably lower than Germany’s corresponding figure of 6.3% for the same period. Since then, the difference has continued to increase in Germany’s favor. China may have dropped to 2.5% export reliance, reflecting stagnant world demand.
Chinese manufacturing production is mainly devoted to domestic demand, given that “the vast majority of goods produced in China remains in China,” as Rothman stated. In 2011, out of the total income from the sale of industrial products, only 12% came from exported goods.
Debunking the China export dependency phenomenon means that exports contributed far less to Chinese GDP. This suggests that any prescription to revive growth cannot rely on excess production and opening of export markets. Certainly, these help, but they cannot fix deeper structural issues and transformations owing to China’s very success by themselves.
This Could Spark China’s Economic Collapse in 2016
Services are not as efficient as manufacturing and construction. In other words, more service jobs (some say 35%) are needed to match the GDP contribution of manufacturing. This means that China needs time, a decade or more, to reach a new equilibrium in order to see the double-digit growth rates of the recent past.
Even if we concede that this explanation is valid, there is the reality that many Chinese provinces are running large debt loads in a phenomenon not unlike the 2007-2009 subprime model where loans were encouraged. In China’s case, rather than debt being encouraged to sell derivative-based mortgage products between banks, credit was easily available to encourage domestic demand, which was already showing signs of weakness. Then there is the problem of overproduction, which is rather ironic for “communist” China as this is a classic issue of capitalism.
Sponsored Content: (Video) Dow Jones 7,000 Trigger Leaked by 28-year Old Stock Research Firm
Nothing reflects this better than automobile production, which helped drive several European economies in reconstruction after World War II. As noted by The Wall Street Journal, General Motors and Volkswagen have reduced production because of good old-fashioned drops in sales. And this is one area where China cannot yet compete for significant market share beyond its borders, even in Asia where Korean and Japanese manufacturers are undisputed leaders.
Away from the dry economic factors, China’s economy has been an experiment based on an odd contrast of a communist political regime with a market-based economic system. This was always going to be a challenge. But it was just a matter of time before this system, which we might call commu-libertarianism, was going to stop—and not too subtly at that.
It has left deep skid marks in the form of the massive state interventions with which the Chinese government has come in support of the Exchange. This is in a scenario metaphorically related to the sinking of the Titanic, saving anything that can be saved. The Chinese market’s invisible hand, it turns out, is rather visible and palpable.
The yuan’s devaluation and the collapse of the Shanghai Stock Exchange over the past summer have exposed the fact that China is now becoming a factor in international instability. Investors now fear the most populous country in the world. All because growth is no longer measured with two digits and not even that magical threshold number of seven percent, as official statistics claimed. Indeed, some economists suggest that China’s growth could drop to a level even lower than four percent, which would drive up unemployment in a country where there is no safety net.
Without any compensation or benefits, unemployed Chinese workers can no longer feed themselves, let alone send money to the countryside where hundreds of millions of people have left their families to go to work in factories on the outskirts of big cities. These socio-economic conditions in dictatorial regimes marked by a controlling state and spiraling economic inequality (i.e. China) become highly politically unstable.
China’s Economy Cannot Sustain Double-Digit Growth Forever
Unlike the developed economies, it will soon discover that it is not equipped with sustaining that kind of unemployment, which may already be knocking at the door. Moreover, this represents a major challenge to the tacit understanding between the people and their rulers.