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Is the Chinese economic model doomed or is the Western business press making much ado about nothing? Last month we witnessed how China’s falling stock markets, and the subsequent inadequate responses from Chinese regulatory authorities, were blamed for subsequent falls in worldwide stock markets. Many analysts scrambled for answers, insinuating that the precipitous decline in China’s stock markets must have had something to do with fundamentals—there must be something seriously wrong with the Chinese economy. An editorial in the Global Times argued that the Western investors’ panic is overdone. “The stock market’s sharp fall is like a fever, but foreign media describes it as a cancer. If so, the market plunge seven years ago would have ended the China model.”
While the jury is still out on whether or not the Chinese economy has cancer, the Global Times editorial does send a correct message: in China, the stock markets have very little to do with fundamentals. Typically, stock markets in China are driven by government announcements of loosening or tightening fiscal policy, and changes to monetary policy. Last year, public announcements by government officials on the health of the stock markets helped drive up share prices to exorbitant levels. Other actions, such as announcing that banks will have to hold smaller reserves in order to free up more money for lending (whether or not companies are in a mood to borrow) has driven stock markets higher.
If stock markets were really driven by fundamentals in China, they would not have risen dramatically over the last twelve months while slower growth targets were simultaneously being announced by Chinese authorities and commodity prices were crashing. Similarly, the fall of China’s stock exchanges (stocks in Shanghai have fallen more than 39 percent since mid-June) have little to do with the underlying economy and more with punters cashing in their gains before the Ponzi scheme collapses. The same panic in the U.S. markets (the Dow Jones Industrial Average lost 6.6 percent in August—its worst performance in three years) has very little to do with fundamentals in China, for few U.S. companies have significant profits coming out of China.
Analysts are now blaming a slowing manufacturing sector in China as Western markets continue to decline, and Beijing’s gross domestic product (GDP) growth forecast of 7 percent is also being questioned. Other analysts are probing further into such growth indicators as electricity usage, commodity prices and cement production to arrive at growth rates close to half the target.
Concern over China’s growth (data released this week showed manufacturing sector slowing at the fastest pace in three years) prompted the central bank to cut interest rates and loosen bank lending—measures which again triggered panic in stock markets worldwide. And in an effort to support its manufacturing sector, the yuan has also been allowed to weaken in order to make Chinese exports cheaper to purchase by other countries.
Economists have long argued China needs to move away from an economy driven largely by cheap manufacturing and toward one based on services and domestic consumption. This shift is already happening, as consumption contributed 50 percent of GDP growth and manufacturing approximately 30 percent. Market watchers also argued that the Chinese stock markets are overvalued, yet many were willing to gamble. Despite the recent froth having been taken off the stock markets, many of the 9 percent of Chinese who invest in the stock markets in China have made money, though their earnings will do little to boost domestic consumption spending. The irrational exuberance of the Chinese stock market bubble is in the process of deflating.
But what of the argument that the U.S. markets will further deflate due to disappointing manufacturing data coming out of China? If we hold the other components of GDP constant, even a halving of manufacturing growth will take little off growth, since it only accounts for one-third of GDP and declines could be offset by growth in other sectors, should the Chinese government chose to stimulate agriculture, infrastructure or consumption through a variety of means.
The above sectors are the ones which could come under attack in the next few days, as market analysts try to point to other weakening components of the Chinese GDP as the cause for the fall of worldwide stock markets. Yet, with all eyes on China, how well the Party leadership responds to these concerns with greater transparency and guidance may continue to drive stock market volatility worldwide in the coming weeks.