Bear In A China Shop

 

They don’t happen too often (thankfully) but the theatre of ‘Black Monday’ can’t have escaped many in the world……great stuff for our gloom-addicted media.

 

For the uninitiated, the situation may seem head-scratchingly complex and that the world is about to explode. So, with my patronising hat on, here's a bite size guide.

 

DIY Investors

The story of China has been one of extraordinary growth in the last decade but there have been recent concerns that there will be a significant economic slowdown. One worry is that this would trigger panicked reactions from investors and lead to a stock market crash.

 

With China establishing its Shanghai stock exchange only in 1990, its market is considered immature compared to the rest of the world. In addition, the shares are almost entirely owned by domestic traders, many of whom are amateur investors with little experience in investing. The lack of large, experienced and professional organisations as investors means that the market is much more volatile.

 

China Central Bank

Over the last few months, China's central bank has been repeatedly propping up the stock market to ensure stability……it has been buying shares to keep them artificially high instead of allowing the natural effects of elasticity and demand / supply. There has also been a cutting of central bank interest rates, which allows more money to flow easily.

 

After losses last week on the Shanghai stock exchange, there was an expectation that there would be yet another such drastic move. But that did not happen and caused panic to ripple out and a dramatic drop in shares on Monday (worst single day plunge since 2007).

 

Yuan

As I blogged recently, one of the possible triggers for the market drop was the earlier decision by the central bank to devalue the yuan and allow it to trade more flexibly.

 

Unlike most currencies, the Chinese currency is not allowed to trade freely according to the number of buyers and sellers in international markets. Instead, the central bank sets a daily rate to the US dollar and for the rest of the day, the yuan is allowed to trade up / down from that rate. Earlier in August, the bank cut that rate by almost 2%, sending a first wave of insecurity through markets. The move was seen as an attempt to help exports by making Chinese goods cheaper abroad.

 

China Now A Big Deal

What recent events have shown us is how much of a linchpin China's stock market is in the global marketplace. China's market was broadly irrelevant 35 years ago but the simple fact is, they have grown to be the second largest economy in the world and this makes China a far bigger deal these days.

 

Rude Awakening

Monday's global turmoil sparked fears of another international financial meltdown but in general analysts say it was merely over-inflated markets correcting themselves. Time will tell. As for China itself, analysts say that as the market matures over the years and investors become more experienced, it will become less volatile. This could also happen if China's Government removes some of the restrictions that hinder foreign ownership of shares, paving the way for bigger more professional firms to come in and inject stability. Currently foreigners only own 2% of stocks.

 

The reality is, China's economy is still expected to slow which in turn would affect the global economy, particularly Western growth. But many anticipate that China’s Government will continue to prop up the economy (one way or the other!) and even more so in light of this recent financial volatility.

 

It's difficult to see the Government in China allowing the economy to slide further without some countervailing action. History tells us that they tend to be meddlers after all!