Chinese economic progress was sharply curbed on Friday when both major indexes fell more than 7 percent. With the Shanghai and Shenzhen falling 7.4 and 7.9 percent respectively, the drop came at a volatile time. While this major piece of news was all but ignored, and with relatively good reason, Americans should be seriously concerned.
As Europe struggles to get the likes of Greece, Portugal, Italy and Spain back on their feet, global attention strayed from China under the assumption of guaranteed growth. Even token growth has been hard to come by though. For the past year or so, the Chinese economy has been relatively weak, but stock prices had yet to respond.
With a weak economy, share prices tend to decline, but to this point in China, stock prices continuously grew while economic growth remained insignificant.
Share prices have also fallen in the face of stricter regulations. When authorities increase their oversight, periods of instability should be expected. Regulation changes the landscape making investors tepid and uncertain of the future. Uncertainty leads to instability and to a certain extent, this volatility was predicted. The Chinese government has repeatedly warned investors of the risk, but of the companies growing 80 to 100 fold in the past year alone, few headed regulator’s advice.
Despite Friday, both Chinese markets have significant, multi-year gains to boast. Such gains appear to be slipping away though. While still up 160 percent in the past two years, the Shanghai composite has seen significant decreases, approximately 18 percent, since the start of June. The Shenzhen’s decline has been even more precipitous, losing 30 percent in the past few weeks alone.
This decrease is a market correction away from overvalued companies.
Government policy has protected debt-saddled public companies in the past but times have changed for China. As a product, smaller scale investors reliant largely upon borrowed money bore the brunt of the downturn on Friday. Times have also changed on a broader scale.
Nowadays, all economies are linked in an international market. Not two decades ago, misfortune for one country’s finances would not preclude a same day gain for another. Now though, when such a vast economy like China’s sees a one-day, seven percent decrease, the rest of the world braces itself. Friday this train of thought was proved perfectly. As China’s market was the first to open, Friday spelled downturn for everyone as economies struggled in the wake of struggles in the Far East.
In response, Hong Kong acted swiftly and decisively. On Saturday, interest rates were cut and reserve requirements were reduced immediately. It seems as if China, after witnessing the potential consequences of a policy change, is reticent. For the worlds fastest growing economy, relative stagnation is one thing but contraction is another animal.
Every country is worried about contraction. No one wants a shrinking economy, but the international market is more volatile and vulnerable than ever before. Contraction in China would spell disaster, and even a double dip. Unfortunately, the world is far less prepared for another recession than it was in 2008.
While this may simply sound like a fear-mongering statement, it’s true. Regulators have already pulled every trick out of the bag. Interest rates are already basically zero. Reserves are at minimums. Bailouts, while plentiful, are not a strategy to count on. And as Chinese regulators attempt to balance a movement towards capitalism with the protection of powerful, debt saddled public companies, the world will watch anxiously and attentively.