The real reason to worry about China isn’t what you might think

Pay no attention to that Party member behind the curtain. The great and powerful Chinese government has spoken. Stocks are going up, and economic growth isn’t going down.

(That should work, right?)

Well, no. Beijing is finding out that gravity applies to financial markets just as much as anything else. What goes up, at least for no reason, must come down, even if you spend $200 billion trying to deny that reality. Indeed, that’s how much China’s government has shelled out on its various stock market interventions, which, it turns out, have all been for naught. The Shanghai Composite fell another 0.2 percent on Wednesday to drop 38.8 percent below its June peak, even lower than it was before Beijing began buying stocks. It’s been enough to convince the government to stop doing so … just as soon as its parade commemorating the 70th anniversary of the end of World War II is over. It apparently doesn’t want another sell-off to spoil the festivities.

The question, though, is why anybody cares that China’s stock market is crashing. After all, it’s not like it contains any information about China’s economy. The Shanghai Composite shot up 150 percent from last June to this one not due to stronger profits or growth—those were both falling—but rather to high school dropouts borrowing money to buy stocks that sounded lucky or like they had something to do with technology. It might have been the most obvious bubble ever, and it’s just doing what every bubble does: bursting. Not only that, but barely any Chinese people, or anyone else for that matter, owns any shares. The financial fallout should be limited. So again, what’s the big deal?

Well, it’s not what China’s stocks tell us about its economy. It’s what China’s stocks tell us about its government. For a long time, the Party seemed like a policymaking wizard that could not only conjure up a brain, a heart, or courage at the nod of a head, but also 10 percent growth. Not anymore, though. Beijing blew a bubble it should have known was unsustainable, bungled the bailout, and doesn’t seem to have much of a plan now—not to mention the fact that its economy might be slowing down more than it wants or admits. Why? Because the government doesn’t want to do the things that would hurt its economy in the short-run, but it needs to do to help its economy in the actually-not-so-long-run.

Now, it’s true that China has gotten rich enough that, no matter what its government does, its economy can’t help but slow down. But it’s also true that it might slow down a lot more than that if Beijing doesn’t ditch its addiction to investment-led growth. And that’s why the stock market crash has gotten so much attention. Rather than rebalance its economy, Beijing just talked up a bubble, saying in April that it was “just the start of the bull market,” to try wean its economy off its debt, but not its investment, dependence. The idea was that companies would be able to sell shares into the booming market rather than having to borrow the money they needed. It wasn’t much of a plan, but at least it was one. What is it now? The answer, it seems, is finding scapegoats. Beijing has forced people to buy stocks, threatened to send them to jail for selling them, and even made a journalist “confess” to inciting panic. A prominent hedge fund manager has also gone in for questioning or been taken into custody—it isn’t clear which—in a crackdown against markets themselves. That isn’t an auspicious sign for a government that needs to keep liberalizing its economy to keep it growing.

China’s commitment to markets, in other words, is only as strong as its share prices.

But the bigger problem is that Beijing has been equally erratic when it comes to the country’s currency. For the first time in a long time, money has been moving out of China, which has made the yuan “want” to weaken. It hasn’t, though, because the government hasn’t let it. Beijing has pegged the yuan to the dollar, and it has defended that peg by drawing down some of its $3.6 trillion in reserves. (Selling dollars to buy yuan pushes up the value of the latter). But this hasn’t just been a matter of spending money. It has also been a matter of un-printing money. That’s because every time the government bought a yuan, it was basically sucking that yuan out of the economy—and, as a result, slowing it down a little more. Beijing has tried to offset this by cutting interest rates and letting banks lend out more money, but that has meant it’s wasted a precious policy tool on fighting the stronger dollar rather than fighting its weaker economy.

So it made sense for China to devalue the yuan. It just didn’t make sense for China to devalue the yuan the way it did. Instead of doing so all at once, Beijing only did so a little. But that, as Paul Krugman explains, only makes markets expect more devaluations, which, in turn, makes more money leave the country—and puts more pressure on the yuan to, yes, devalue. It’s been bad enough that the government has had to make betting against the yuan more expensive to try to keep more money from leaving the country. Mission not accomplished.

If you know what Beijing is up to, you should probably tell them since they’d like to know too. The government has wasted hundreds of billions trying to reinflate a stock market bubble and hundreds of billions more trying to keep the yuan from falling too much. The only thing that is clear is that Beijing is panicking … and maybe you should too? That, at least, is what global markets have been doing whether or not they depend on Chinese growth. It sure seems like an overreaction. U.S. stocks might have been a bit overvalued, but should they be swooning so much over weak Chinese manufacturing and import numbers? There isn’t any sign that China’s economy is dragging ours down. If anything, ours might be picking up ever-so-slightly.

It should take a lot more than a bucket of cold water from China to make the U.S. melt.


Text: The Washington Post by Matt O’Brien 02-09-2015

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