While the Greek debt crisis and the Iran nuclear deal are all the buzz in the media, you may have noticed a major selloff on the Shanghai Stock Exchange over the last several weeks. There are global implications when the stock market of the world’s second largest economy is out of control, and the impact could be felt right here in the U.S.
China is a country of superlatives. Its population of more than 1.3 billion is larger than that of any other country. Its foreign reserves are about $4 trillion. The Chinese government owns $1.27 trillion in United States bonds.
As recently as the early 1990s, China was a minnow on the global trading stage, now it is the world’s largest exporter. It has helped lift hundreds of millions of citizens out of poverty and its per capita GDP has more than tripled since 1980.
Now that China has established itself as an economic powerhouse fueled by rapid growth, its foreign policy is becoming increasingly aggressive. It is asserting territorial claims over much ofthe South China Sea and their cyber-attacks on both business and government networks in the United States are creating a potential bipolar global rivalry with America just as the Cold War with the Soviet Union did.
China has evolved a system of state capitalism since the government began to introduce some market forces into the economy in the late 1970s. But the government is still the dominant economic actor despite all of President Xi Jinping’s rosy rhetoric about allowing markets forces to play a decisive role in allocating key resources and investment decisions.
The last two months have felt like a rollercoaster for the estimated 90 million retail investors in the Chinese stock market. With the government hoping companies would raise capital in the stock exchanges rather than seeking bank loans, novice investors bought stocks on margin with huge amounts of borrowed money, helping to create a stock bubble and runaway bull market.
Over the last several weeks the Shanghai Stock Exchange was down 30 percent. While no single factor appeared to spark the selloff, analysts attribute it to fear of slowing economic growth and the worldwide slowdown in demand for Chinese exports.
Fearing the slide might cause the economy to fall off a cliff, it was met with heavy-handed intervention by Beijing. The government cut interest rates, suspended trading for 1,400 companies, banned short sales, prohibited major shareholders from selling shares to stop the selling stampede and halted new initial public offerings.
The United States had better hope China doesn’t decide to bail out its stock market and stimulate its economy by starting to cash in some of its United States bond holdings. If that happens, U.S. interest rates will rise whether the Federal Reserve likes it or not. Of course, Japan and OPEC may step up and buy the U.S. debt if interest rates rise and U.S. bonds become more attractive.
The Chinese government’s tight control of the stock markets is not exactly consistent with allowing market forces to allocate financial resources. It’s unclear whether a government-dominated economy can have a free stock market.
International Monetary Fund chief Christine Lagarde recently said that, “China is still learning how stock markets work.” And that learning curve could have a big impact here on the other side of the world.
Originally Published: August 8, 2015