I’ve spend four to five weeks a year in China. Out of all trips to date, perhaps most noteworthy, It was my trip to Beijing when the Chinese stock markets closed trading early when its circuit breakers triggered. And, as we all know and witnessed, as China’s market valuations were precipitously dropping, many of the world’s markets followed suit. What’s going on, what’s going to happen, and what should we do? To find the answers to these questions, I spent every day this past week reading the local Chinese news (in English, of course) and also the news from abroad, studying the daily releases of Chinese economic reports, talking to friends and also tohigh level corporate executives in China. I combined all of this new information with the knowledge that I already had on China. Here are my answers.
First, what happened?
Why did China’s stock markets experience a free-fall during the first week of trading in 2016? The Chinese regulators erred. They installed market-wide circuit breakers into their stock markets. The way a circuit breaker works is that it shuts down and closes the trading day if the market is down by a specific percent. Installing circuit breakers into the Chinese markets was a big mistake. Sure, the NY Stock Exchange uses circuit breakers too, but that’s also controversial. In China, its stock markets already use daily price limits (in China, individual stock prices cannot fall by more than 10% per day), and its marginal investors seem to be the uninformed, speculative, individual investors. So, the imposition of circuit breakers was not only repetitive to its price limit system, but it also only served to incite panic rather than to reduce it. Think about it. China is a place where there isn’t a whole lot of transparency to begin with. So, if I’m a somewhat clueless individual investor in China, and one day I see that Chinese regulators suddenly install circuit breakers in fear of a market crash, then naturally I’m going to panic. And this is what happened. The Chinese regulators now see it this way too, which is why they recently removed the circuit breakers. On one hand, this is all comical, but on the other hand, it’s extremely frustrating.
Some economic data or news justified the Chinese market collapse.
This is not true. I tried to look at every piece of economic news that was announced or released during the first week of this year’s trading in China, and there was nothing that should have justified China’s market free-fall. I read the many international news stories that tried to pin the blame on some economic news, but every explanation that was offered was neither convincing nor plausible. You might think that this is not possible, that every stock market crash has an economic-based rationale or cause, but consider that there is no consensus economic rationale behind the 1987 U.S. stock market crash. So, “causeless crashes” are not unprecedented; it even happened in the U.S.
The Chinese government is intentionally pushing down its stock market valuations to prevent a bubble or to reduce the value of its currency.
Not only is this not true, but it’s also ludicrous. The Chinese government and regulators have been doing everything they can to prevent the stock markets from falling.
China is going into a recession.
I highly doubt this. Sure, the estimated Chinese GDP growth rates of about 7% in 2015, and forecasted to about 6-7% for 2016, are kind of hard to believe, but even the most skeptical economists in China still believe its GDP growth rate will be about 3% in 2016. A 3% growth rate is not great, but it’s still positive growth and beats what the U.S. has been doing lately. And a 3% GDP growth rate certainly does not put China into recession territory, especially for an economy that has already grown a lot recently.
U.S. markets heavily depend on China’s economy.
Again, not true. The amount of sales that the U.S. has in China represent a very small portion of our GDP. If you don’t believe me, then consider this… the U.S. has been complaining about its trade imbalance with China for many, many years. And if it is true, that the US economy depends on China, then the US should be happy that the USD is depreciating, as it should help the Chinese economy. The U.S. stock market simply overreacted to China’s market free-fall. The US has a history of doing this. Remember when the US markets irrationally panicked over Greece, even though the size of Greece’s economy and international trade are miniscule within the context of the global economy?
Chinese banks are going to collapse.
It is true that Chinese banks suffer from significant problems such as shadow banking. However, the Chinese government is so paranoid about this problem that I doubt it will lead to a banking collapse. The Chinese government has the U.S. to thank for this, because they saw what not-to-do as they watched us let our financial institutions and financial system crumble in 2008.
So, what is true?
Chinese are not consuming.
The Chinese government realizes that it cannot rely on exporting forever for its country’s income and wealth, so they are trying to shift the country to move toward a greater reliance on consumption to boost their GDP. But it is simply not happening, at least not amongst the rising middle-class. This is one reason why the economy is not growing as well as it has in the past.
China wants to weaken its currency, the RMB, for now.
While China is trying to find other sources of economic growth, it seems like they will keep reverting back to a reliance on exporting as they figure it out what else to do and what else will work. And a way to export successfully is to make its currency weak.
The Chinese economy will grow.
It is not a matter of if, but when, China will become the world’s largest economy. There are lots of people who criticize China’s economic policies, but consider that its transition to a market-based economy is still very much at its beginning stages. In context, China is truly remarkable in its ability to learn and in its ability to adjust quickly. My estimate is that during the next 20 years, China will contribute at least a half billion additional people to the global middle class, which is both the engine and benefit of economic growth.
Keep an eye out for China, and don’t rule anything out.
