August 27, 2015    3 minute read

As the Chinese sneeze, who will catch a cold?

   August 27, 2015    3 minute read

As the Chinese sneeze, who will catch a cold?

The initial fall in Chinese markets has continued to gather momentum and with that momentum comes increasing anxiety. Concerns about China’s stock market have been evident for a number of years due to its relative immaturity and its large composition of small, inexperienced traders – creating increased volatility.

“Black Monday” saw the Shanghai Composite nearly face the biggest decline possible given daily limits – down 8.5%, the worst in 8 years. While The Nikkei dropped by 4.6%, The Dow opened more than 1,000 points down and European bourses were down around 4-5%. Furthermore, emerging markets are taking their share of the pain. With only safe government bonds from the likes of the USA and Germany doing well, currencies, commodities, oil, and even gold are taking hits.

Causes

A possible trigger could be seen as the decision by the central bank to devalue the Yuan and allow it to trade more flexibly. The Yuan is not allowed to trade freely, with a daily rate set to the US dollar for the rest of day, with which the Yuan can trade 2% up or down. This rate was cut by almost 2% in early August of this year in a supposed attempt to help exports by reducing the price of Chinese goods abroad.

This sent a first ripple of insecurity through the markets and around $5 trillion has been wiped off global stock market prices since then. The “Black Monday” meltdown was then perpetuated by disappointing data released on the previous Friday, suggesting that China’s industrial activity is falling, and sharply. There seems to have been a breakdown in communication between China and the rest of the world, as the Chinese government failed to clearly express how it plans to manage their economy in the future, with its lack of clear strategy spooking investors. In the modern era this is undoubtedly a question that affects the whole world.

Outcomes

Even with all the panic across global markets we look at recent events in context. The Shanghai Composite is still up a mere 43% this year and the knock on effects of this week should be limited to the short run. However it is still a somewhat rude awakening for global investors who have let their attention on China falter. As mentioned previously, the market domination of small-time investors may lead to Chinese market volatility becoming more commonplace. Thus far the Chinese government is yet to fully utilise its strongest market interventions. Investors should be concerned but by no means panic. Fundamental questions are being raised about China, an economy accounting for 15% of global GDP and around 50% of global growth, without a sufficient rebalancing act a descent into stagnation is very much possible.

The growth models of many emerging economies rely on Chinese demand for commodities, thus the weakened Chinese growth and falling currency are both working to put pressure on such countries. This may be the end of emerging market growth as we have known it. Indexes and currencies have been falling with the fuel of Chinese growth, low interest rates and high commodity prices seemingly being a thing of the past now. Global economic growth may be left to the rich economies across the world which is a worrying outcome, as European and American recoveries still having lasting scars.

The meltdown of “Black Monday” and “Tumble Tuesday” are unlikely to result in a new financial crisis or systemic risk to the banking sector, but the Chinese must work towards a more functional market if it wants to lead a more sustainable growth trajectory.

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