The mood has changed in international markets. Investors are becoming more pessimistic about recovery in the world economy and of the likely direction of share prices. Concern has centred on the Chinese economy. Forecasts are for slower Chinese growth (but still around 5 to 7 per cent) and worries centre on the impact of this on the demand for other countries’ exports.
The Chinese stock market has been undergoing turmoil over the past few weeks, and this has added to jitters on other stock markets around the world. Between the 5th and 24th of August, the FTSE 100 fell by 12.6%, from 6752 to 5898; the German DAX fell by 17.1% from 11,636 to 9648 and the US DOW Jones by 10.7% from 17,546 to 15,666. Although markets have recovered somewhat since, they are very volatile and well below their peaks earlier this year.
But are investors right to be worried? Will a ‘contagion’ spread from China to the rest of the world, and especially to its major suppliers of raw materials, such as Australia, and manufactured exports, such as the USA and Germany? Will other south-east Asian countries continue to slow? Will worries lead to continued falls in stock markets as pessimism becomes more entrenched? Will this then impact on the real economy and lead then to even further falls in share prices and further falls in aggregate demand?
Or will the mood of pessimism evaporate as the Chinese economy continues to grow, albeit at a slightly slower rate? Indeed, will the Chinese authorities introduce further stimulus measures (see the News items What a devalued yuan means to the rest of the world and The Shanghai Stock Exchange: a burst bubble?), such as significant quantitative easing (QE)? Has the current slowing in China been caused, at least in part, by a lack of expansion of the monetary base – an issue that the Chinese central bank may well address?
Will other central banks, such as the Fed and the Bank of England, delay interest rate rises? Will the huge QE programme by the ECB, which is scheduled to continue at €60 billion until at least September 2016, give a significant boost to recovery in Europe and beyond?
The following articles explore these questions.
Articles
The Guardian view on China’s meltdown: the end of a flawed globalisation The Guardian, Editorial (1/9/15)
Central banks can do nothing more to insulate us from the Asian winter The Guardian, Business leader (6/9/15)
Where are Asia’s economies heading BBC News, Karishma Vaswani (4/9/15)
How China’s cash injections add up to quantitative squeezing The Economist (7/9/14)
Nouriel Roubini dismisses China scare as false alarm, stuns with optimism The Telegraph, Ambrose Evans-Pritchard (4/9/15)
Markets Are Too Pessimistic About Chinese Growth Bloomberg, Nouriel Roubini (4/9/15)
Data
World Economic Outlook databases IMF: see, for example, data on China, including GDP growth forecasts.
Market Data Yahoo: see, for example, FTSE 100 data.
Questions
- How do open-market operations work? Why may QE be described as an extreme form of open-market operations?
- Examine whether or not the Chinese authorities have been engaging in monetary expansion or monetary tightening.
- Is an expansion of the monetary base necessary for there to be a growth in broad money?
- Why might the process of globalisation over the past 20 or so years be described a ‘flawed’?
- Why have Chinese stock markets been so volatile in recent weeks? How seriously should investors elsewhere take the large falls in share prices on the Chinese markets?
- Would it be fair to describe the Chinese economy as ‘unstable, unbalanced, uncoordinated and unsustainable’?
- What is the outlook over the next couple of years for Asian economies? Explain.
- For what reasons might stock markets have overshot in a downward direction?
On August 11th, China devalued its currency, the yuan, by 1.9%. The next day it devalued it by a further 1.6% and on the next day by a further 1.1%. Even though the total devaluation was relatively small, especially given a much bigger revaluation over the previous three years (see chart below), traders in world markets greeted the news with considerable pessimism. Stock markets around the world fell. For example, the US Dow Jones was down by 1.1%, the FTSE 100 was down by 2.5% and the German DAX by 5.8%.
There are three major concerns of investors about the devaluation. The first is that a weaker yuan will make other countries’ exports more expensive in China, thereby making it harder to export to China. At the same time Chinese imports into the rest of the world will be cheaper, thereby making it harder for domestic producers to compete with Chinese imports.
The second is that cheaper Chinese imports will put downward pressure on prices at a time when inflation rates in the major economies are already below target rates. The fear of deflation has not gone away and this further deflationary twist will intensify such fears and possibly dampen demand.
The third is that the devaluation is taken as a sign that the Chinese authorities are worried about a slowing Chinese economy and are using the devaluation to boost Chinese exports. The rapidly expanding Chinese economy has been one of the major motors of the global economy in recent years and hence a slowing Chinese economy is cause for serious concern at a time when the global economy is still only very slowly recovering from the shock of the financial crisis of 2007–8
But just how worried should the rest of the world be about the falling yuan? And will it continue to fall, or could this be seen as a ‘one-off’ correction? What effect will it have on the macroeconomic policies of the USA, the eurozone and other major countries/regions? The following articles analyse Chinese policy towards its currency and the implications for the rest of the world.
China weakens yuan for a third straight day on Thursday CNBC, Nyshka Chandran (13/8/15)
Markets reel as investors fear worst of Chinese slowdown is yet to come The Telegraph, Peter Spence (12/8/15)
China cannot risk the global chaos of currency devaluation The Telegraph, Ambrose Evans-Pritchard (12/8/15)
Beware a China crisis that could crash down on us all The Telegraph, Liam Halligan (15/8/15)
The curious case of China’s currency The Economist, Buttonwood’s notebook (11/8/15)
China’s yuan currency falls for a second day BBC News (12/8/15)
China slowdown forces devaluation BBC News, Robert Peston (11/8/15)
What the yuan devaluation means around the world BBC News, Lerato Mbele, Daniel Gallas and Yogita Limaye (12/8/15)
China allows yuan currency to drop for third day BBC News, various reporters (13/8/15)
The Guardian view on global currencies: it’s the economy, stupid The Guardian, Editorial (14/8/15)
China’s currency gambit and Labour’s debate about quantitative easing: old and new ways to cope with economic crisis The Guardian, Paul Mason (16/8/15)
Questions
- By what percentages have the nominal and real yuan exchange rate indices appreciated since the beginning of 2011? Use data from the Bank for International Settlements.
- Explain the difference between nominal and real exchange rate indices.
- Compare the changes in the yuan exchange rate indices with that of the yuan/dollar exchange rate (see Bank of England Interactive Database). Explain the difference.
- How is the yuan exchange rate with other currencies determined?
- How have the Chinese authorities engineered a devaluation of the yuan? To what extent could it be described as a ‘depreciation’ rather than a ‘devaluation’?
- Why have world stock markets reacted so negatively to the devaluation?
- Why, in global terms, is the devaluation described as deflationary?
- How much should the rest of the world be worried by the devaluation of the yuan?
- Explain the statement by Robert Peston that ‘Beijing has done the monetary tightening that arguably the US economy needs’.
- Comment on the following statement by Stephen King of HSBC (see the second Telegraph article below): ‘The world economy is sailing across the ocean without any lifeboats to use in case of emergency.’
Many Chinese people have taken to investing on the Chinese stock market, seeing it as a way of making a lot of money quickly. From October 2014 to June this year the market soared, rising by 126% from 2290 to 5166.
More and more people used their savings to buy stocks and China now has over 90 million individual investors. And it was not just savings that were invested. Increasingly people have been borrowing money to invest, seeing it as an easy way of making money. Unlike stock markets in developed countries, where the majority of shares are held by financial organisations, such as pension funds, holdings by individuals account for about 80% of stocks on the Chinese market.
But since mid-June, share prices have plummeted by 32% (see chart). People have thus seen a huge fall in the value of their savings, while many others have found their shareholdings worth less than their debts. The fall, like the rise that preceded it, has been driven by speculation, fuelled by first optimism and then pessimism.
The Chinese government is worried that the fall might dampen investment and economic growth. It has thus has been supplying liquidity to various institutions to buy shares, but this has had little effect and is dismissed by many as meddling. What is more it could expose companies which take advantage of the liquidity to greater risk.
So serious has been the rout, that over 50% of listed companies have halted trading on the mainland Chinese stock exchanges.
So just why has there been this bubble and why has it burst? What implications will it have for (a) China and (b) the rest of the world? The following articles explore the issues.
China’s stock market fall hits small investors BBC News Magazine, John Sudworth (7/7/15)
China Stocks Plunge as State Support Fails to Revive Confidence Bloomberg (8/7/15)
Chinese stocks are crashing Business Insider UK, Myles Udland, David Scutt (8/7/15)
Shanghai stocks plunge, over 1,200 Chinese companies halt trading Economic Times of India (8/7/15)
Everyone freaking out about China’s stock-market crash is missing one thing Business Insider UK, Elena Holodny (7/7/15)
China’s stock market has lost nearly a third of its value in a month Vox, Timothy B. Lee (8/7/15)
Chinese leaders may be undermined as investors suffer stock market slide The Guardian, Emma Graham-Harrison (8/7/15)
Opinion: China’s stock-market crash is just beginning MarketWatch, Howard Gold (8/7/15)
What does China’s stock market crash tell us? BBC News (22/7/15)
Questions
- What is meant by a ‘bubble’? Has the recent performance of the Shanghai Stock Market been an example of a bubble?
- Is the current fall in share prices in China an example of overshooting? Explain how you would decide.
- Distinguish between stabilising and destabilising speculation. Why does destabilising speculation not go on for ever?
- What is meant by the ‘stock market wealth effect’? How is the fall in the Chinese stock market likely to affect consumption and investment in China? How does the proportion of assets held in the form of shares affect the magnitude of the effect?
- What are the likely implications of the fall in the Chinese stock market for the rest of the world?
- Why has the Hong Kong stock market not behaved in the same way as the Shanghai market?
- What have the Chinese authorities been doing to arrest the fall in share prices? How likely are they to succeed?
According to a report by the McKinsey Global Institute, global debt is now higher than before the financial crisis. And that crisis was largely caused by excessive lending. As The Telegraph article linked below states:
The figures are as remarkable as they are terrifying. Global debt – defined as the liabilities of governments, firms and households – has jumped by $57 trillion, or 17% of global GDP, since the fourth quarter of 2007, which was supposed to be the peak of the bad old credit-fuelled days. In 2000, total debt was worth 246% of global GDP; by 2007, this had risen to 269% of GDP and today we are at 286% of GDP.
This is not how policy since the financial crisis was supposed to have worked out. Central banks and governments have been trying to encourage greater saving and reduced credit as a percentage of 
GDP, a greater capital base for banks, and reduced government deficits as a means of reducing government debt. But of 47 large economies in the McKinsey study, only five have succeeded in reducing their debt/GDP ratios since 2007 and in many the ratio has got a lot higher. China, for example, has seen its debt to GDP ratio almost double – from 158% to 282%, although its government debt remains low relative to other major economies.
Part of the problem is that the lack of growth in many countries has made it hard for countries to reduce their public-sector deficits to levels that will allow the public-sector debt/GDP ratio to fall.
In terms of the UK, private-sector debt has been falling as a percentage of GDP. But this has been more than offset by a rise in the public-sector debt/GDP ratio. As Robert Peston says:
[UK indebtedness] increased by 30 percentage points, to 252% of GDP (excluding financial sector or City debts) – as government debts have jumped by 50 percentage points of GDP, while corporate and household debts have decreased by 12 and 8 percentage points of GDP respectively.
So what are the likely consequences of this growth in debt and what can be done about it? The articles and report consider these questions.
Articles
Instead of paying down its debts, the world’s gone on another credit binge The Telegraph, Allister Heath (5/2/15)
Global debts rise $57tn since crash BBC News, Robert Peston (5/2/15)
China’s Total Debt Load Equals 282% of GDP, Raising Economic Risks The Wall Street Journal, Pedro Nicolaci da Costa (4/2/15)
Report
Debt and (not much) deleveraging McKinsey Global Institute, Richard Dobbs, Susan Lund, Jonathan Woetzel, and Mina Mutafchieva (February 2015)
Questions
- Explain what is meant by ‘leverage’.
- Why does a low-leverage economy do better in a downturn than a high-leverage one?
- What is the relationship between deficits and the debt/GDP ratio?
- When might an increase in debt be good for an economy?
- Comment on the statement in The Telegraph article that ‘In theory, debt is fine if it is backed up by high-quality collateral’.
- Why does the rise is debt matter for the global economy?
- Is it possible for (a) individual countries; (b) all countries collectively to ‘live beyond their means’ by consuming more than they are producing through borrowing?
- What is the structure of China’s debt and what problems does this pose for the Chinese economy?
One thing that economists often argue for is free trade. It promotes competition, allows greater choice and generates efficiency gains through specialisation to name a few of the advantages. Barriers to trade have gradually been brought down across the global economy, but some do still exist.
Although free trade does have many advantages, there are also arguments for barriers to trade, especially for developing or emerging economies. In some cases, barriers to trade can help a country to develop a particular industry or offer protection to a new sector from the giants of the world. In the case of China, it had a quota system in place since 2009 to restrict exports of ‘rare earth materials’, such as Tungsten and Molybdenum. Many of the hi-tech products that China specialises in require these rare minerals during production and, as the dominant producer of these minerals, Beijing had imposed restrictions on exporting them in an attempt to develop these industries.
However, other countries had raised concerns about the quota system being used, suggesting that by restricting exports of rare earth minerals, China was driving up their price. It was also suggested that the restrictions benefited domestic producers, at the expense of foreign competitors, given that domestic producers were able to access the raw materials at cheaper prices.
A complaint was made to the World Trade Organization in March 2014 by the USA, supported by the EU, Canada and Japan. Following an investigation by a WTO panel, the panel found that China had failed to show sufficiently that the quotas were justified. After an appeal by China, the panel’s findings were upheld in August by the WTO.
In response to the failure of its appeal, China has just announced that it is removing the quotas on exports of rare earth materials. However, this is unlikely to be the end of the story, as other policies may well be imposed, including a resources tax; and an export licence is still required. The following articles consider this battle.
China axes rare earth export quotas Financial Times, Lucy Hornby (5/1/15)
China scraps quotas on rare earths after WTO complaint BBC News (5/1/15)
China ends rare-earth minerals export quotas Wall Street Journal, Chuin-Wei Yap (5/1/15)
China scraps rare earth export controls after losing WTO appeal Bloomberg (6/1/15)
China abolishes rare earth export quotas: state media Reuters (4/1/15)
Questions
- What are the benefits of free trade?
- Why do some countries choose to impose protectionist measures and what type of measures can be put in place?
- Using a diagram, explain the impact that export quotas would have on Chinese firms using these rare minerals and also on foreign firms.
- Why have other countries argued that export quotas push up prices of these minerals?
- What other policies might China put in place in order to protect its industries?
