Can a market meltdown in China take down the global economy?
Photo: Yemeky. Source: Dreamstime
Investors are finally waking up to the fact that a stock market crash in the world’s second largest economy—one three quarters the size of the Eurozone—might be more important than a currency crisis in the world’s 44th largest economy—an economy slightly bigger than Pakistan’s. While global headlines have been preoccupied with Greece and the possibility of a “Grexit,” stock markets in China have fallen by over 33%.
Only a month ago many analysts were worried that Chinese equities were in a bubble. Valuations seemed excessive. The market had risen almost 60% from year-end and 150% from a year ago. Despite a well-documented economic slowdown, stocks seemed to defy gravity. The market’s total value approached $10 trillion—greater than the size of their economy.
But then the market began to pull back, and margin-related accounts had to sell shares to cover their loans. This built on itself. Securities firms—some of the highest flyers on the way up—were hit especially hard on the way down. Concerns mounted that many of those loans would turn into losses.
Over past three years, the US has grown steadily while Europe and the rest of the world has stumbled. China’s market began to take off about a year ago, and has given back about half of those gains so far. Right now their market is still about 10% higher than it was in December.
The greatest concern to the global markets would be if market losses in China somehow threatened real economic growth. That could happen if bad margin loans caused a major brokerage house to fail, leading to a credit crunch, or if market losses weigh on consumer sentiment and lead to a reverse “wealth effect.” Most importantly, the lack of transparency in the Chinese financial system—with its back-door financing channels and loose accounting standards—means that contagion risk within China is high. We just don’t know what we don’t know.
20 years ago, after stepping down as Premier, Deng Xiaoping noted that markets weren’t perfect and the government could shut them down if need be. Hopefully it won’t come to that.
Douglas R. Tengdin, CFA
Chief Investment Officer
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