A Chinese investor uses a magnifying glass to look at his mobile phone screen as he monitors stock prices at a brokerage house in Beijing. ©AP Photo/Ng Han Guan

China won't crash the global economy... yet

If the last three decades have been a roaring success, the next decade is much more complicated
July 9, 2015

Since 12th June, more than $2.7 trillion has been wiped off China’s stock market, equivalent to three months of the country’s economic output and some six times the value of the Greek foreign debt that is mesmerising Europe. This slide continues, despite increasingly desperate efforts by the Chinese government to stop it: emergency measures have included cash injections by the central bank, interest rate cuts, relaxed collateral rules, warnings on stock market manipulation—no sense of irony there—obliging brokerage houses to set up a $19bn fund to buy shares, with a pledge not to sell until the market recovers, and a suspension of new flotations.

Nothing has worked and by 8th July some 40 per cent of the companies listed had asked for trading in their own shares to be suspended, for fear of being obliterated. It began to look like Armageddon.

But appearances can be deceptive: this is not Wall Street 1929 or even 2007. Staggering though the figures are, the stock market still represents around 2 per cent of the Chinese economy. Despite dropping more than 30 per cent to date, the market is still up nearly 70 per cent on a year ago, when the same Chinese government set the bubble off by relaxing account rules and repeatedly announcing a bull run in state media. This is a market with Chinese characteristics.

Small investors piled in on the government’s signal: with 112m Shanghai trading accounts and 142m in Shenzhen, there are, famously, more small investors in China’s volatile shares than there are members of the Communist Party. The 20m new trading accounts that opened earlier this year testified to the faith that these small investors, short of safe harbours for their savings, have that the government that had backed the boom would not let them down.

Many of these latecomers have suffered, but despite the recent drama, many other investors are still up on the year. What the share slide has damaged, however, is the impression that the Chinese government cultivated, and many foreign investors in China’s economy were as eager to believe as China’s small traders—that the economic success of the last three decades was evidence of the infallible wisdom of the Chinese Communist Party.

The government needed that impression to hold, as it seeks to steer the cumbersome economic ship past the rocks of the middle income trap. The old growth model is over: rising wage levels, chronic over capacity, poor demographics and multiple inefficiencies speak to the need for reform in an economy that the last Prime Minister, Wen Jiabao,  called “unstable, unbalanced, uncoordinated and unsustainable.” The current Communist Party General Secretary, Xi Jinping, has described the challenge of maintaining stability and implementing reform as “more onerous than ever.”

There is every reason to believe him. The growth target of 7 per cent—the new normal after three decades of double digit growth—would still be healthy, but many analysts believe that the true figure this year could be less than 5 per cent. The party needs domestic consumers to step up, to ease the transition to a higher value, more innovative economy. The party has promised economic reform, including reform of China’s powerful but inefficient state-owned enterprises,  a cut back in unproductive investment and a greater role for the market.

The plan is moving slowly, if at all. The state-owned enterprises remain unreformed, over-production continues and most of the torrent of massive overseas infrastructure projects announced in recent months to export China’s over capacity remain at the drawing board or MOU stage. The property market, the asset of choice in the boom years, remains in a slump, with huge volumes of unsold properties on the books, much of it faltering collateral for local government debt.

Since 1960, only 12 economies have made the transition from middle to high income status. All had higher levels of education and lower levels of inequality than China, though none was a continent-sized economy. On the other hand, none had China’s inverted pyramid demographics, the result of three decades of a one-child policy, with the simultaneous burden of a shrinking workforce and a growing pension bill.

China’s 200m pensioners will be 400m in five years’ time. They are unlikely to be big spenders. Their children and grandchildren will bear much of the burden of their care, as well as paying for their own children’s expensive education, and may have little left for discretionary purchases. Add to that the accumulated corporate and local government debt—some 282 per cent of gross domestic product—and the government’s evident anxiety to prop up its faltering stock markets begins to make more sense.

If the last three decades have been a roaring success, albeit with a toxic environmental legacy, the next decade is much more complicated. Perhaps the biggest casualty of the last few weeks has been the reputation of a leadership that has claimed the credit for China’s boom and must now bear the blame if the transition falters. The party is not loved, and the steady tightening of domestic security measures in the last two years nods to the fear that the post-1989 bargain of rising prosperity in return for a politically passive population may not hold. Transitions can be volatile moments.

This is not good news for the government. Nor is it good news for a world economy that has come to rely on China’s continued success as the engine of global growth. China’s stock markets are a domestic problem. The knock on effects could be everybody’s.