So China is Doomed Because of a 30% market crash … ?

gay men in paradeThe news is abuzz with China’s recent stock market crash.  The naysayers are all coming out.  Not that they were ever hiding, but now it’s a parade – with horns and drums to toot!

Some reports are however darn right silly.  For example in this CNBS report titled How China might have given itself a black eye, a reporter would first accuse China of committing the sin of fighting in vain against market forces, then accusing China of not being able to do enough.

Then there are outlets like Wall Street Journal pronouncing China is doomed to fail, and then a few days later pronouncing everything is fine. There are of course also those who swear that they had foreseen the crash all along, for umpteenth obvious reasons.

Here is my take.

First, there is in general no clear-cut answer on how much government should intervene to stabilize a market – stock, housing, insurance, currency, whatever – or to fix the economy in general.  China is not an isolated island.  Within it, there too are debates about how much government should intervene in the market.  What is the right or wrong answer depends on the specific details of complicated circumstances, many of which are not – let’s be real – well understood.

Second, whatever the proper balance, it is certainly not true that only Chinese government is unique in getting involved in “stabilizing” markets as it did this past week. The U.S. – through its quantitative easing – and European Union – through their version of it – have done similar things – on a grander scale.  The Japanese government have also famously gotten involved in directly purchasing stocks to try to stabilize stock market (and currency) at various times through the last several decades. Governments throughout the world, including that of the U.S., European Union, Japan, Russia, Brazil, and India have all intervened in the currency markets for in recent history.

Third, the fact that Chinese market dropped 30% also per se should not be a cause for fright.  In the U.S., market drops happen with surprising frequency and regularity.  Here is a table summary of a history of crashes going back to the early 1928. 1

Crash StatisticsAgain, I understand this is for the U.S. market, not China’s market.  And there are many differences (but as well as similarities as well) between U.S. and China, but a crash of 30% per se should not spook the long term outlook.  Crashes are part of the norm of markets – stocks, futures, real estate, whatever.

Fourth, there are many that are predicting that China’s fall in market will precipitate a fall in its economic growth – i.e. gdp growth.  Again, I fail to understand.  It is well known that stock market performance and economic performance are, if at all, at best weakly correlated.  It is stupid to predict that China’s economy will sputter solely on the ground that its stock market crashed this year.

Finally, I don’t have a crystal ball and don’t claim I can predict the future (The world is awash with smart people making dumb predictions of the future, and I don’t intend to join their ranks. 2), but I do know that the kind of predictions and reasoning I see given by people for their sour predictions of China’s future this past week look to be just hot air.  Hot air fuming out of their mouth … but smelling very much like the type coming out their other ends…

 

Notes:

  1. See http://www.fool.com/investing/general/2013/08/19/what-i-plan-to-do-when-the-market-crashes.aspx
  2. People fundamentally can’t predict stocks, or sporting events with any consistency, so why should anyone think they can predict a game changing historical event as China’s rise?  Conversely, if you really think you can really predict the future, why aren’t you a billionaire now???

11 thoughts on “So China is Doomed Because of a 30% market crash … ?

  1. In 2007, China’s stock market also dropped more than 30%. It doesn’t affect the growth of China’s core economy, which grow from $4 trillion to over $10 trillion today. But this time the scale is a lot bigger. The stock market grows from $3 trillion in 2014 to around $ 7 trillion in June 2015, then dropped by $3 trillion.

    As I have said in Cheung’s post, China’s market is fundamentally unstable due to the excess saving of China’s citizens, over $ 10 trillion in mainland bank alone, but no better channel for investment other than property. Although China’s economy is the largest in the world, Chinese companies made up 20 of the 500 largest corporation! And the Chinese companies that made it to the list are mostly state controlled enterprises which unfortunately paid little dividend.

    This episode actually shows both the strength and weakness of China’s economy. The Chinese consumers have access to over $10 trillion cash that they can take out or put into any market. The down side is China’s small and medium sized companies (which are listed in the stock market) are still not that big or competitive.

    However, the future is bright as China is now the largest market for automobiles, computer, cell phones, box office, pretty much all food products, even beer consumption is doubled the next placed US. In reality, China’s is pretty much the largest market for most of the largest 500 corporation in the world. And there is still potential for growth as the average consumption is still low.

    The question is, should China’s savers and investors channel their fund into creating new MNC or simply take over foreign ones? For the latter case, Volvo, Pirelli, AMC Theatres, Smithfield Foods, IBM PC, Putzmeister are good example. For me, it would be better and easier to do the takeover route as it would not cause any ripple.

    My suggestion is China should start a few state funds that allow savers to invest in bond, option etc. These state fund should invest in all companies with good revenue or potential worldwide. Of course it won’t be easy as there are so many detail to sort out.

  2. I think there is the problem of opposition of U.S. government in the takeover game, as Tsinghua is attempting to takeover Micron, and probably be opposed by U.S. commerce Department on national security concerns. China has trillions of dollars to invest in her social security fund and some has suggested to invest in the market. I think although the limit is 30% I still think it’s a bad idea. The rescue of bettors in stock market should be a low priority as the drop of $3 trillion is only in paper as it went up by $4 trillion previously. I think a better investment is to consolidate all the local government debts into long term bonds with lower interest and social security can invest on them for better return while cutting the cost for local governments.

  3. Yes, a lot US politicians are delusional about China’s tech capability, take a look as this older writing.

    It is harder to invest in the US than the EU. China is way behind the rich countries in outbound foreign direct investment (OFDI). However, it must be done for China to keep developing.

    http://www.thechinamoneyreport.com/2015/06/27/china-to-become-worlds-biggest-overseas-investor-by-2020/

    “While early Chinese investments focused on energy and natural resource assets
    in developing countries, investors are increasingly looking to the US and Europe
    for fresh opportunities. Between 2000 and 2014, Chinese companies spent €46bn
    on 1,047 direct investments in the 28 EU countries, with most of the transactions
    coming in the wake of the 2008-09 global financial crisis.

    The UK is by far the biggest recipient of Chinese direct investment, with a
    cumulative total of €12.2bn over that period. Germany is second with €6.9bn and
    France third with €5.9bn. Following a drop in 2013 to €6bn, from more than €7bn
    each year in 2011 and 2012, Chinese investment in Europe came surging back in
    2014, hitting a record high of €14bn for the whole year.

    Europe’s energy, automotive, food and real estate sectors attracted the most Chinese
    money. Despite the recent sharp rise and heady predictions for Chinese outbound
    investment in the future, the country is still playing catch-up.

    While China is the world’s biggest trader of goods, its share of global financial
    cross-border assets and liabilities barely reached 3.4 per cent by 2011.

    Today, its stock of OFDI as a proportion of GDP stands at just 7 per cent, compared
    to 38 per cent for the US, 20 per cent for Japan and 47 per cent for Germany.
    One issue that could stymie the rise of Chinese investment is the ongoing difficulty international companies face trying to invest in China.”

  4. In the west, state or pension fund etc can only invest in AAA rating companies or economy. Credit rating agencies like Moody’s, Standard & Poor, and Fitch are pretty much king makers above the law. In their rating, US and EU govnt bond are all AAA while China is only A.

    I am also against blind investment of pension fund into stock market. However, I feel that as China is the largest market for say VW, Daimler, BMW, Hyundai, Samsung, Airbus product why shouldn’t the govnt invest in them? Currently, I feel that in some areas there are over investment in China but in other areas woefully under invested. I do not think that all bridges, airports are over investment but large luxury govnt buildings and vanity projects definitely fall into this category. China’s software and people’s investment are way behind the curve. Today, 20% of high school grads might be able to attend college, a tremendous improvement compare to just 1% 30 years ago. However, I noticed that there are severe shortage of professional in medical, engineering, specialized field.

    This shortage doesn’t necessary mean these are tertiary level position. For example, in the US there are close to half a million people with private aviation license. In China the figure is just over 4,000! The govnt should invest in technical training schools for many of the shortages in China’s economy. This is what I think the govnt should use the excess foreign reserve currency for. At present China hold over $1 trillion dollar and over $1 trillion Euro, mostly in foreign govnt bond getting 3% return. It is just sad. They can gradually cut those figures in half and invest in its own people. Those money are better spent setting up schools, hospitals and training the workforce for them. There are also excessive shortages for these position pretty much all over the developing world. If the govnt would increasing the medical, technical assistance given it would help China’s overseas investment as well. For example, if there are state own companies operating mines in Gambia, the govn’t should set a rule that a certain percentage is used for setting up medical mission in that country. China presently has medical teams all over the world, but I don’t mind seeing them increased by a hundred fold.

    On top of that, the govnt can set up fund to allow the trillions of people to save and invest. At present, most local govnt only way of development is investment in structure and business but very few into the people. In my view, the growth has to be channel in that direction. My idea is nothing new, Finland has similar govnt fund for any citizen that want to pursue advanced education. China should have something similar. It costs only about $30,000 to train a commercial pilot. A typical commercial pilot makes over $1 million in his career, what better investment than that? However, more than 2/3 of Cathay Pacific pilots are expatriates. I think this is pathetic.

  5. My July 18th post states that China has 20 companies in the top 500, it is based on 2013 market capitalization figure. The latest Fortune Global 500 ranking list 106 Chinese companies by revenue. https://en.wikipedia.org/wiki/Fortune_Global_500

    I largely take market valuation with a pinch of salt. For example, UK’s stock market is larger than Germany and France.

  6. According to this wsj report:

    [Xi’s] image as a bolder, more capable leader than his recent predecessors is being undermined by his botched handling of the stock market rout, a sudden devaluation of the yuan, an economic slowdown and a massive explosion at a toxic chemical warehouse.

    A few points:

    1. So Xi “botched” manipulating the stock market? No, the purpose of the government actions have never been to ensure that the stock market will rise, or that no one loses money in the market … it’s to make sure there is no wild speculation in the market… In fact, the Chinese gov’t has been battling real estate and stock market bubble the last few months (in the case of real estate, last few years).

    So what if the market falls a little more? All the fall erased this year’s gain … and what so of that? As if the market is a measure of Chinese economy? As Warren Buffett has explained many times, the market will do what the market does … which consist of irrational movements divorced from fundamentals and reality. When investors buy, they should buy based on long-term fundamentals, and accept the fact that the future is fundamentally unknowable and go from there. Even Buffet cannot time the market. A corollary to that is that many of Buffet’s investments fall a lot – sometimes 30-40% – after he purchases, but ultimately turned Buffett a handsome profit. Don’t read too much into market ups and downs…

    2. As for the yuan devaluation, the U.S. dollar has gone on a tear the last year or two. With the Yuan pegged to the U.S. dollar, most economists concede that the Yuan has become over-valued. The fact that the Chinese gov’t allowed market forces to devalue the Yuan … by liberalizing the range within which Yuan is exchanged … is a far-cry from devaluing the Yuan. If you want a gov’t that is actively doing that – it is the Japanese government (as a key pillar of Prime Minister Abe’s famed notion of Abenomics) – not the Chinese government!

    3. As for Chinese economic sputter? The Chinese government has been trying to slow the economy for some time, to increase the”quality” of economic growth, instead of striving for sheer numbers type improvement. In an attempt to move China higher up the global trade value chain, in order to reduce green emission, in order to develop its economy to be more robust and independent, to develop a service industry that rival and outflanks its export industry, the past type of economic growth has to curbed. The Chinese economy is shifting to a new normal, as the Chinese gov’t has promise it will lead it. Of course there are risks, and of course there will be challenges, but slow down per se, a stock market fall here and there per se, are not signs per se of China’s collapse as so many seems to be pontificating!

    4. As for Tianjin’s recent explosion, I don’t understand how this is a direct or even indirect reflection of Xi’s leadership. Many people have definitely come to see the explosion as a symbol of China’s growth. But the truth is that rules were broken, and corners were cut. We have industrial accident – sad as they may be – are a part of industrial societies (see e.g., this wiki entry), to politicize individual tragedies … for political bickering … is sad … and demeaning…

  7. About that recent devaluation of the yuan: here is a wall street journal report that says that yuan’s devaluation is more about market reform than gov’t manipulation … after all…

    WASHINGTON—China’s sudden decision last month to devalue its currency riled neighbors and fueled investors’ fears about a sharp slowdown in the world’s No. 2 economy. But the move has won over the International Monetary Fund and even secured restrained praise from the U.S. Treasury Department.

    For more than a decade, the U.S. and other countries castigated China for its currency policy, saying the yuan’s level gave the country’s exporters an unfair advantage at the expense of its trading partners. The Aug. 11 depreciation initially spurred worries in global financial markets as investors saw it as a signal that Beijing was reverting to its old policy playbook in a desperate effort to revive a flagging economy.

    A number of China experts and Western officials close to the matter say China likely isn’t regressing.

    “If they wanted to revert to their mercantilist trade policies, they would have moved sooner and they would have moved by a much bigger amount,” said Nick Lardy, a China expert at the Peterson Institute for International Economics.

    Instead, economists are generally viewing the depreciation as China presented it: as a move to make the country’s exchange rate more market-determined. ….

    The currency decision “was a brilliant technical move,” said Hung Tran, executive managing director of global capital markets at the Institute of International Finance, an industry group representing around 500 of the world’s largest banks, funds and other financial institutions.

    The change in currency policy was part of a yearslong bid to get the IMF to include the yuan in the elite basket of reserve currencies that comprise its lending reserves, those people say. For now, China appears to be moving further in that direction by allowing market forces to move the exchange rate.

    “I think a lot of countries are going to vote in favor of it,” said Mr. Lardy, of China’s bid to get the yuan labeled a reserve currency. Several major Western powers have said they back the effort.

    The US Treasury’s initial response was guarded. But after a phone call with Chinese Vice-Premier Wang Yang late last month, Treasury Secretary Jacob Lew praised China’s efforts to make its currency more market-determined and its exchange-rate policies more transparent.

  8. It used to be that the RMB pegged its rate to the US$. However, now that China’s trade with rest of the world represent 3/4 its trade, it is not realistic to ignore RMB valuation with other major currency, as the likes of Euro, Yen, Can$, Au$ etc have depreciated greatly against the US$, it is appropriate for RMB to be pegged to a basket of currency.

    2/3 China’s foreign reserve are non-US$. These currency has depreciated by around 20%. As a result, China’s foreign reserve has dropped by over US$200 billion the last few months. The negative results of having huge reserve.

  9. More concessions from Wall Street Journal that the convention wisdom is all wrong … and that the perspective presented in this post is right…

    http://blogs.wsj.com/economics/2015/09/03/what-if-the-china-panic-is-all-wrong/

    China’s stock-market routs and economic deceleration are widely cited as the major trigger for the latest round of global market volatility. But what if the dominant narrative about China—that the world’s No. 2 economy is on the verge of falling off a cliff—is wrong?

    Here are some of the arguments that might moderate market fears:

    • China’s stock market valuation is a bad indicator of Chinese growth.

    “Investors should not get carried away by the collapse of the Shanghai Composite Index,” warns Melanie Debono from Capital Economics in note to clients, “not least because its performance often bears little relation to that of the economy, primarily due to wild swings in its valuation.”

    Market vs. GDP China

    The market run-up in advance of the selloff was out of step with reality, says Nick Lardy, a China expert at the Peterson Institute for International Economics. That’s why he says there’s likely more to come in the Chinese market correction. Even after the rout, “The market was still trading at 39 times earnings. Give me a break, it’s still too high.”

    • The devaluation of the renminbi likely isn’t Beijing scrambling to save the economy through competitive devaluation.

    Beijing’s depreciation was likely more about addressing a key concern for the International Monetary Fund as it considers whether to include the Chinese yuan in its basket of currencies that comprise its lending reserves than it was about reviving economic growth by juicing exports.

    On Aug. 11, Beijing changed the way it values the yuan, allowing markets to play a greater role in the exchange rate. Market pressure has long been for depreciation, so allowing the currency to be more market-determined would, in the near-term, naturally see the yuan move lower.

    Against a basket of global currencies, the yuan has appreciated over the last year by nearly 15%, accounting for inflation. That’s despite Beijing intervening for months to prevent the yuan from losing value.

    “So the fact that the yuan came down 3% to 4% is not going to make much difference,” said Ted Truman, a former top international finance official at the U.S. Treasury and the Federal Reserve.

    • GDP growth may not be nearly as bad as suspected.

    Economists such as Clare Howarth at Oxford Economics say that beyond official industrial production figures, data on car and cell phones sales are jacking up the risk that China’s growth stalls.

    But “critics are really overlooking the fact that the growth model has changed in China,” Lardy says. “The service sector is now the driver of growth. So the fact that industrial growth has slowed down quite a bit does not mean, as it would have meant 10 years ago, that the economy is falling off a cliff.”

    Based on electricity consumption, “I just don’t see any signs that the Chinese economy is experiencing a hard landing,” says Torsten Sløk, Deutsche Bank’s chief international economist.

    Electricity Consumption of China

    • Rather than regressing to policies of old, China’s government has actually been showing signs of moving ahead with market reforms.

    Beijing’s economic policy makers know that even though structural overhauls will moderate growth in the near-term, they’ll also bolster long-term growth and help stave off a major deceleration.

    In fact, Beijing has moved ahead with promised plans to liberalize the economy. For example, even amid the major stock-market correction, Beijing opened up the interbank markets to central bankers, sovereign wealth funds and financial institutions. The central bank has also been moving ahead with interest-rate liberalization, though in more measured steps than perhaps many in the U.S. would prefer.

    “It’s very clear that the challenges that are springing up now are the results of structural policy deficiencies,” said Zheng Xinli, deputy director of the Chinese People’s Political Consultative Conference economic committee. “Further reform and correct policy rebalancing can certainly provide the potential for ongoing robust economic growth,” he told the Council on Foreign Relations last week.

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