China’s stock market crash is not the beginning of a global economic downturn, or the start of a Chinese recession. But it is a reminder of just how fragile China remains, and how far it still is from the status of a global power.
Red is China’s favourite colour: not only does it traditionally symbolise good luck, but it also happens to be the Marxists’ favourite tint, so it is ideologically approved by China’s ruling Communist Party. Apart, that is, from when red flashes on the computer screens of stock markets, where it signifies falling share prices. Yet that’s precisely the only red Chinese leaders current encounter: Shanghai’s main stock market has dipped by 22 per cent since last week, and is down almost 45 per cent since its peak in June.
Predictably, such spectacular financial gyrations have produced equally spectacular comments from analysts. For some, the sharp falls in Chinese financial markets are like the canary in the coal mine, an early indicator of an even sharper impending fall in the global economy, as China collapses into a downward economic spiral, dragging the rest of the world with it. But for those who belong to the ‘this time is different’ brigade, the events on the Chinese market are merely a ‘correction’ from previous financial bubbles, and are unlikely to flummox China’s supposedly super-efficient, ‘technocratic’ leaders, who will emerge triumphant from this crisis, just as they have done from previous ones.
Yet the reality is almost certainly more nuanced than these stark alternatives: China’s current financial troubles are not so much a harbinger to a Chinese and global meltdown, but they are a pretty good and timely reminder of the severe limitations inherent in China’s rise to superpower status, and the extreme fragility of the country’s political system. And it may, just may, provide the spark to a far bigger dispute inside China’s Communist Party.
Keep Calm and Don’t Speculate
It is understandable why China’s current troubles are receiving such attention and generating so much anxiety. For the first time since pre-Industrial Revolution times, China has achieved an economic size and significance that has put it back on the geopolitical map; what China does or does not do matters. Still, it’s worth pointing out that, provided the Chinese crisis does not deepen or take a different manifestation than just drop in the stock market prices, its impact on the global economy in general and Europe in particular is likely to be limited. According to Eurostat, the EU’s statistical agency, European Union exports to China account for 10 per cent of all EU exports, not including intra-European trade, and are valued at around 1 per cent of European gross domestic product: important in the current fragile global economic market, but not exactly catastrophic.
The City of London, the transit point to over two-thirds of China’s total investment in Europe, may also be affected by a prolonged Chinese economic downturn. And Germany, Europe’s economic engine, is also liable to be hit, since it is Europe’s biggest exporter to China, which buys 5.5 per cent of Germany’s total non-European exports. Still, the picture is not entirely negative. For although European exporters may suffer, producers may benefit from much lower energy and other raw material prices which are also a by-product of China’s economic slowdown. And, arguably, London benefits too. The worse the financial situation gets in China, the bigger the capital flight from that country, and the bigger the benefits for City of London’s fund managers; that, after all, is what happened when the Soviet Union collapsed and, subsequently, when the Russian economy went into meltdown.
Some global commodity producers, such as Venezuela, Columbia, Brazil or Iran, will suffer terribly from a Chinese prolonged downturn, if that is what confronts us. But governments in many of these countries are already inimical to the operation of the global economy under current rules, so if such governments get into trouble, the world won’t mourn.
Matters may get more tricky should a Chinese downturn last for years. That would affect growth rates in some key African countries such as Mozambique, Angola and Nigeria, and hit the fragile recovery experienced throughout the African continent. It will also affect Australia, whose economy is already hit by the reduction in Chinese demand for raw materials. But that is still not the immediate danger.
To be sure, darker scenarios can be painted. In desperation, China may resort to competitive devaluations (as opposed to the one-off devaluation that has already taken place) in order to prop up its export-dominated economy, dragging the other ‘Asian Tigers’ down the same road and triggering off a broader trade war which may, if matters are not handled correctly, result in ‘deglobalisation’, namely a return to trade barriers and tariffs world-wide. But such doomsday scenarios remain far off, partly because China knows that it is likely to be the biggest victim from such trade wars, but also because a competitive devaluation would wipe off years, if not decades, of Chinese efforts to court its Asian neighbours.
Nor should one exaggerate the impact of the current bloodbath on the Shanghai stock market on China’s broader economy. For the reality is that, despite the establishment last November of a formal link – or ‘Connect’ - between the Shanghai and Hong Kong stock markets which allows mainland and Hong Kong investors to trade shares on each other’s bourses, Chinese stock markets are nowhere near what most others would recognise as a traditional stock markets.
They are not the place where companies raise cash, the mediators between investors and entrepreneurs: only an estimated 6 per cent of the capital requirement of Chinese-owned companies is raised yearly on the stock market, with the rest provided by banks, often on the basis of political or personal ‘guanxi’, the individual and corporate connections which are the real oilers of the Chinese economy. Nor are stock markets the place where the nation keeps its savings, or old ladies safeguard their pensions: less than one in thirty Chinese owns any listed equity (in the UK, this is one in ten), and just 2 per cent of all equities are owned by foreigners (in the UK, it’s just over 50 percent, according to Britain’s Office for National Statistics) Riddled with insider dealing and other forms of financial mismanagement, China’s stock market is most emphatically not the bellwether for the country’s economy.
China’s financial crash is important for different reasons. First, because it punctures the Chinese government’s claim to deliver ever-increasing prosperity, coupled with market stability; China’s leaders are discovering what Britain’s Gordon Brown also realised: that claims to have abolished national economic ‘boom and bust’ are rashly made, and repented at leisure.
Exposing the Chinese Leadership’s Vulnerabilities
Not many Chinese own stocks or know what a stock market looks like or what it does, but they do understand financial panics, and they are easily riled by them: after all, most Chinese families remember when their lives’ savings were wiped out – not once, but twice – by the predecessors of the current communist leaders over the past half century. So, the mere fact that prices of assets are falling and that the government seems powerless to prevent it affects the Chinese leadership’s claim to good governance: an imponderable but important development.
The way the Chinese leaders handled the crisis also tells us a great deal about the country’s political vulnerabilities. They resorted to every administrative measure, from cutting interest rates, to lowering banks’ reserve requirements and ordering state financial companies to buy stock in order to halt the slide in prices. And they even announced a small currency devaluation.
Yet all of this smacked not only of desperation, but also of a lack of coordination, and of a lack of a deeper understanding about how markets function. For instance, far from reassuring. the devaluation of the currency spooked people into thinking that competitive devaluations are in the offing. And, after adopting a ‘leave markets alone’ policy for a period, the Chinese government resumed its heavy-handed intervention. The bottom line is that although there are plenty of officials in China who understand financial markets, the top leaders who approve decisions in time of emergency speak no foreign languages, talk to nobody outside their small circle of acolytes and have no idea of what makes markets and people tick. That has always been China’s Achilles heel, as it is for any authoritarian state: the idea that the Chinese have invented a miraculous system which preserves absolute power in the hands of a tiny self-selecting elite but somehow still allows for ‘technocrats’ to make sensible ‘meritocratic’ decisions was always nonsense, and remains nonsense, as the handling of the current crisis indicates.
The Way Ahead
And the other reminder from the stock market panic is about how skewed the Chinese economy really is. The real estate and investment boom at home – largely fuelled by state-owned companies with the encouragement of local and central government authorities – has left the country with significant overcapacity in various economic fields but particularly in construction, with rising debt management problems in non-financial companies, and with property bubbles throughout the country. Consumer spending by households is only 35 per cent of GDP, one of the lowest levels in the world. And the productivity of this investment is astonishingly poor.
A way around the problem exists. China should channel its excess savings abroad, and offer local companies new export and sales markets. It would need to embrace open and transparent governance, accept that it cannot control capital flows, exchange rates and interest rates, and that it should allow capital markets to run their own affairs. Beijing would also have to realise that it needs to establish an independent judicial system to enforce contracts, reduce speculation and fight corruption. The current stock market collapse is a reminder of just how far China is from all these things.
It is unlikely that, as a result of the current economic troubles, China may seek overseas military adventures; it is a myth that vulnerable governments just invent foreign conflicts in order to divert attention from domestic troubles. But it is true that the Chinese rulers are unlikely to show much flexibility or offer too many concessions abroad, while they are cornered at home; expect a rather downcast State Visit by President Xi Jinping to London in October, and a similarly downbeat summit with US President Barack Obama at around the same time.
But, on a more positive note, we are also likely to hear less about grandiose schemes for creating ‘Silk Roads’ and a variety of ‘bridges’, all financed by the Chinese around the world. The easy times for China are over; the hard slog is about to begin. And it would be surprising if it won’t lead to cracks in the current system of government.
The views expressed here are the author's own and do not necessarily reflect those of RUSI.
Associate Director, Strategic Research Partnerships