Recent events in Shanghai’s stock markets have been all too reminiscent of the tales that have entered American folk memory from the days of the Wall Street crash in 1929: of stock-tipping shoeshine boys, exhausted traders, and ticker-tape machines spooling late into the night.
In China, the Shanghai Composite Index lost more than 8% of its value last Monday, and shares have suffered their worst month for six years, falling by 29% since they peaked in June.
America’s great crash, and the policy failures that compounded its effects, helped to trigger the great depression. Partly because of the lessons learned then and since, few analysts believe China is heading for an economic downturn on that scale. But there are growing concerns about what the stock price rollercoaster reveals about the health of the world’s second largest economy.
Christine Lagarde, the managing director of the International Monetary Fund, played it cool when asked about the Chinese market gyrations in a press conference on Wednesday. She pointed out that the market was still up an extraordinary 80% over the past year, and added she was not surprised the government in Beijing was intervening to prevent the “disorderly functioning” of markets.
“That is the duty of central authorities,” she said. “The fact that they want to maintain a level of liquidity that is commensurate with an orderly process is quite good.”
In other words, while some have condemned Beijing’s efforts to arrest the share slide as clunky and authoritarian, Lagarde saw it as little different to the scramble by western governments during the 2008 crisis to prevent their financial systems from seizing up.
She was relaxed, too, about the potential impact of the share price slide on China’s real economy – the shops, factories and farms that create jobs and generate growth. “We believe that the Chinese economy is resilient and strong enough to withstand that kind of significant variation in the markets,” she said.
Yet many analysts believe that as well as the bursting of a financial bubble, the downturn in the stock market reflects a wider economic slowdown.
Robert Shapiro, a former economic adviser to Bill Clinton, who now works at US consultancy Sonecon, says: “The Chinese leadership have had a fundamental policy of driving growth sufficiently great to generate employment for about 10 million people a year. The main way they’ve done this is through public investment, or semi-public investment. A lot of these projects are now going bust, because there’s nobody to purchase the apartments, and there are no businesses to rent the offices.” He says the market chaos is partly a direct result of this phenomenon, as shares in construction and property firms are hit.
The investment slowdown is a part of a deliberate and carefully signalled policy by China’s president, Xi Jinping, to shift growth away from the export-dominated model that brought more than a decade of double-digit growth rates, as China exploited cheap labour to become the undisputed workshop of the world.
Instead, Beijing hopes to achieve the next stage of economic development through more sustainable, domestic-led growth, encouraging urbanisation, and increasing the role of markets. Opening up its stock markets to overseas investors– albeit via intermediaries in Hong Kong – was one step in that process.
Extraordinary strides have been made in tackling urban poverty, and tax cuts have helped to cut the cost of imported goods, but the continued weakness of retail sales has undermined hopes that an army of new consumers would power the economy forward.
And Shapiro argues that China will also have to face up to the legacy of the lending boom that has been key to keeping the economy afloat. “There are huge volumes of bad debts,” he says. “I think that the distortions in the Chinese economy have accumulated, and there is a growing probability of a hard landing.”
Officially, Chinese GDP is still expanding at a healthy rate, in line with the government’s target of 7% a year – which would already be the slowest pace since 1990. But there are questions about the reliability of official figures. China-watchers at City consultancy Fathom compile their own “China momentum index”, based on a number of metrics, including electricity usage and industrial production, and they argue that growth has slowed sharply, to perhaps 3%. Certainly, interest rates have been cut repeatedly in a bid to put a floor under the markets, but also to underpin growth.
“Although policymakers are reluctant to admit that China has slowed dramatically, the recent onslaught of measures aimed at stimulating the economy surely hints at their discomfort,” says Fathom’s Laura Eaton. “While these measures may temporarily alleviate the downward pressure, they do very little to resolve China’s longstanding problems of excess capacity, non-performing loans and perennially weak household consumption.”
Recent sharp declines in global commodity prices, including oil, copper and iron ore, are regarded by many market-watchers as resulting from weak Chinese demand, as its apparently insatiable appetite for the world’s natural resources wanes. A downturn in global trade volumes, too, while it has many disparate causes, can probably also be laid partly at China’s door.
The country’s slowdown is unfolding at a fragile moment for the global economy, with the eurozone crisis far from resolved and the Federal Reserve preparing to increase interest rates for the first time since the global financial crisis.
Professor Danny Quah, an expert on China at the London School of Economics, says: “The US tightening monetary policy amid fragility in the world economy more generally will be challenging for China. Domestic circumstances are tough as well: significant local government debt and already relatively high real wages with thin profit margins remain worries for the economy overall within China.”
But he insists that with $4 trillion (£2.6tn) worth of foreign currency reserves and interest rates still above 4% – instead of at rock bottom, as in the US, UK, eurozone and Japan – Beijing is far from impotent in the face of crisis. “I suspect China’s policymakers have plenty of firepower still to help support economic growth in the short term – for the next five years certainly 7% a year would be manageable,” he says.
But to the extent that Chinese policymakers are forced to dip into their foreign currency war chest to support growth – and particularly if a less export-oriented growth strategy means that it stops racking up the vast trade surpluses that have helped it to accumulate these huge reserves – the ripples will be felt in markets around the world.
Simon Derrick, head of market strategy at investment firm BNY Mellon, says there are signs that is already happening. He says reserves have already been trimmed by about 7.5%, from just under $4tn at the end of June 2014, to $3.69tn by the end of June this year.
Along with other emerging economies that piled up reserves to avoid a repeat of the late 1990s Asian financial crisis, China’s massive buying power in debt markets was one of the pressures keeping interest rates low across the developed world in the runup to 2008.
Derrick believes this shift away from accumulating new reserves could have contributed to the drift upwards in US bond yields, and the downward pressure on a slew of currencies in recent months, including the euro, and the Canadian and Australian dollars. “Suddenly, you don’t have the same support that you’ve had for the past 15 years, which is why you’ve seen so much volatility,” he says.
And as the Fed prepares the ground for a rate rise, Derrick argues that the absence of Chinese buying power in financial markets could mean the impact of that decision is amplified, with borrowing costs rising steeply in the US and emerging markets.
“If there is to be a move higher in interest rates across the board, maybe it will be sharper than perhaps you might have expected maybe five years ago.”
Other countries have ample low-cost labour ready to move into manufacturing as Chinese real wages rise, so it may be through higher borrowing costs, rather than a dearth of cheap toys or T-shirts, where the west will feel the impact of China’s changing economy most keenly.
In Shanghai, meanwhile, the luckless citizens who chose to invest their hard-earned cash in shares are learning the hard lesson – often forgotten even by the world’s most seasoned investors – that markets can go down as well as up.
Global powerhouse with a poverty challenge
ENGINE OF GROWTH … China is the world’s second-biggest economy behind the US, but in terms of who powers growth in the global economy, China is way out ahead. The country has contributed more than a third of global economic growth since 2008-09, so even a moderate slowdown has the potential to send shockwaves around the world.
… BUT STILL DEVELOPING Despite its rapid growth, and predictions that it could even overtake the United States over the coming year, China remains, in the assessment of the World Bank, a developing country. Per-capita income is still a fraction of that in advanced countries. With the second largest number of poor in the world after India, poverty reduction remains a fundamental challenge for China, the World Bank adds.
COMMODITIES Fast-industrialising China has a huge and rising influence on commodity markets. It accounts for roughly half the global demand for nickel, aluminium and copper. So when China slows, commodity prices are hit, mining company shares tumble and the pain is felt in the biggest commodity exporters, such as Australia. China makes up almost a third of Australia’s exports.
ENERGY With its population of around 1.3 billion, China is also the world’s largest consumer of energy, and recent trade figures suggest it is overtaking the US as the biggest importer of crude oil. The majority of its electricity comes from coal but it is also the biggest producer of wind power: and its capacity to generate hydroelectric power dwarfs other countries thanks to plants like the Three Gorges Dam.
STEEL OUTPUT China is the world’s biggest steel producer, making more than 822m tonnes last year, which was half of global output, according to the World Steel Association. China is also far and away the biggest consumer, taking about 46% of finished steel products in 2014, the association says.
LUXURY MARKET An expanding middle class has boosted demand for consumer goods in China and by Chinese tourists on overseas shopping sprees in the US and Europe. It is already the world’s largest car market and accounts for about a third of global smartphone sales. There has also been a surge in demand for luxury goods, such as watches and handbags, although the economic slowdown and a crackdown on officials receiving gifts has dampened this market.