Why is China's stock market falling and how might it affect the global economy?

Katie Allen in The Guardian



What has happened in China?

China’s stock market has fallen sharply over recent weeks despite measures by officials in Beijing aimed at calming investors’ jitters and shoring up global confidence in the country’s slowing economy.

Shares in China had soared 150% in the 12 months to mid-June as individual investors piled into the rising market, often borrowing heavily to do so. But chiming with warnings that shares were overvalued and the signs of an economic slowdown, the momentum came to a shuddering halt when shares hit a seven-year peak.

Following another plunge on what was dubbed “Black Monday”, China’s stock markets have now given up all their gains for the year.

China’s shock move to devalue its currency, the yuan, this month only served to intensify worries about the world’s second-largest economy.

Shares around the world followed China’s stock markets lower. About £74bn was wiped off the value of the FTSE 100 and on Wall Street, the Dow Jones Industrial Average slumped by a record of more than 1,000 points at one stage.

Commodities such as crude oil and copper have also tumbled to multi-year lows as investors take fright over signs of waning demand in the world’s leading consumer of raw materials.

The currencies of emerging Asian economies have weakened as investors drop those assets seen as riskier to hold. But investments perceived as safe havens in times of trouble, such as gold and some government bonds, are in demand.

Is this a repeat of the 2008 global financial crisis?

Some of the falls on stock markets are certainly reminiscent of the swings seen around the time of the collapse of the US bank Lehman Brothers. The FTSEurofirst 300, a pan-European share index, suffered its biggest one-day drop since late 2008, losing 5.4%. For Shanghai’s composite index, Monday’s 8.5% slump was the biggest since February 2007.

But some economists say the parallels stop there. They see limited risk to China’s real economy from the stock market turmoil and little to be worried about beyond China.

Julian Jessop, the chief global economist at the consultancy Capital Economics, said: “The current panic is essentially ‘made in China’. The recent data from other major economies, including the US, eurozone and Japan, has generally been good ... Aside from the bad news from China, there is very little to support fears of a major global downturn.”

But others are less sanguine. They point out that China’s slowdown is just one of many factors worrying investors alongside lingering political problems in the eurozone, signs of weaker global growth and vast sums flowing out of fragile emerging markets such as Brazil. Furthermore, policymakers apparently have few tools left to help.
Should I be worried?

George Osborne, the UK chancellor, suggests not and believes China’s stock market woes will not have much impact on European economies.

But there are plenty of other voices saying this could get a lot worse. 

Larry Summers, the former US Treasury secretary, has suggested that the US Federal Reserve may be forced to ease monetary policy, rather than hiking interest rates in the next few months as had been expected.
— Lawrence H. Summers (@LHSummers)August 24, 2015

As in August 1997, 1998, 2007 and 2008 we could be in the early stage of a very serious situation.
— Lawrence H. Summers (@LHSummers)August 24, 2015

It is far from clear that the next Fed move will be a tightening.

Furthermore, experts say policymakers do not have many tools available to shore up the global economy this time around.

Interest rates are already at record lows and central banks have spent years printing electronic cash in quantitative easing (QE) programmes, cheap money that many blame for the latest market troubles.

Stephen King, the HSBC economist, warned back in May: “The world economy is sailing across the ocean without any lifeboats to use in case of emergency.”

Damian McBride, Gordon Brown’s former spin doctor, spelled out his advice for an impending crash on Twitter.
— Damian McBride (@DPMcBride)August 24, 2015

Advice on the looming crash, No.1: get hard cash in a safe place now; don't assume banks & cashpoints will be open, or bank cards will work.
— Damian McBride (@DPMcBride)August 24, 2015

Crash advice No.2: do you have enough bottled water, tinned goods & other essentials at home to live a month indoors? If not, get shopping.
— Damian McBride (@DPMcBride)August 24, 2015

Crash advice No.3: agree a rally point with your loved ones in case transport and communication gets cut off; somewhere you can all head to.

Another tweet posted later on Monday:
— Damian McBride (@DPMcBride)August 24, 2015

Today is just the stock market catching up with the terror over defaults that's been gripping the bond market for months.

What if I have money tied up in stocks?

Individuals with money invested in shares should not worry too much for now, financial market experts have said.

Nick Dixon, an investment director at the asset management company Aegon UK, said: “If pension savers don’t need to access their fund for many years, they needn’t be alarmed by short term volatility.

“Stock markets are in for a bumpy ride over the coming weeks, but if savers can stomach the ups and downs, equities are likely to provide superior returns over the medium and long term.”
What does it mean for interest rates?

There had been widespread expectation that the US Federal Reserve would start the gradual process of hiking interest rates as soon as next month. Signs of a potential hard landing for China could well stay the central bank’s hand.

The same goes for the UK, where the Bank of England governor, Mark Carney, recently hinted that a rate hike could happen around the turn of the year.

In China, meanwhile, the country’s central bank is widely expected to ease monetary policy further to shore up growth and confidence.

What will this mean for inflation?

A silver lining economists highlight for those countries that rely on imports of oil and other commodities is that this global sell-off will keep prices low. Oil has more than halved from a peak of $115 per barrel last summer to a Brent crude price of less than $44 per barrel now. At least some of that will be passed on to drivers in lower fuel prices.

Philippe Waechter, the global chief economist at Natixis Asset Management, said: “On the upside, the fall in the oil price will be positive news for European economies as consumer purchasing power will be increased.”

What happens next?

Officials in Beijing are under pressure to step in with more measures to restore stability to China’s stock markets. The trouble they face is that every action is also perceived as a further sign of quite how worried they are about the slide in shares and the wider economy.

Bill O’Neill, the head of the UK investment office at UBS Wealth Management, said: “There will be some form of additional stimulus over the next few days and weeks.

“That is likely to be combined with supportive words from developed economy central bankers aimed at offering reassurance that accommodative policies will remain in place regardless of when interest rates start to rise.”

From Thursday, investors will be looking to the US and a symposium of central bankers in Jackson Hole, Wyoming, for signs of how this new bout of market volatility may influence their interest rate decisions.