The Chinese New Year begins on 8 February, ushering out the year of the sheep (or goat, or ram) and bringing in the year of the monkey. People in China will enjoy a week-long vacation and will celebrate with dragon dances and fireworks. Given the financial fireworks emanating from China, this is a good time to briefly review some of the major economic news coming out of the Middle Kingdom.
Chinese stock markets had a rocky start to 2016. On 4 January (a Monday and the first trading day of 2016), share prices on the Shanghai stock market fell by 6.9% from their 31 December close. Two days later, prices fell by 7%. On both occasions, the declines were severe enough to lead authorities to suspend trading. By 15 January, the Shanghai Composite index had fallen about 20% from its 31 December level (see Figure 1).
The fireworks were not confined to China, but spread to the world’s major financial markets. Stock market indices in the United States, Britain, and Japan fell between 7 and 10% between 31 December and 15 January (see Figure 2).
Why did Chinese financial markets get a hangover before the New Year festivities?
China appears to be in the early stages of a cyclical slowdown. ‘Appears’ because it is unclear how severe the downturn is or how far it has progressed, due to the notorious unreliability of China’s official statistics. The poor quality of statistics stems in part from the difficulty of gathering statistics in a large, diverse, developing economy. Some of it emanates from the fact that Chinese official statistics are widely believed to be manipulated to present the impression of steady growth. The Economist notes the “…eerie stability of key indicators … In year-on-year terms, growth over the past six quarters has been 7.2%, 7.2%, 7%, 7%, 6.9% and 6.8%. Such a tight clustering is improbable.”
For those tempted to argue that misleading statistics are hardly the stuff of economic collapse, it is worth recalling that the European sovereign debt crisis erupted in October 2009, when Greece’s actual budget deficit was revealed to be twice the previously (mis)reported official figure.
Anecdotal evidence suggests that Chinese growth has slowed by a percent or two, to a still respectable 5-6%. Even though this decline is not sharp, the ends of cyclical booms can be fraught with danger if they end in a ‘bust.’ That is because economic booms are often accompanied by increasing indebtedness, as individuals and firms increase their borrowing to finance the many profitable opportunities that characterize a booming economy. The longer and more robust the boom, the further down the list of worthwhile projects investors will go until, by the end of the boom, they may have financed some pretty dodgy investments.
When the economic expansion ends—as all economic expansions eventually do—borrowers may find it hard to service their debts, particularly those taken on to finance questionable projects. When borrowers default, the financial institutions that provided the money may be caught short, along with all of their creditors. At the moment, it is unclear how much further China’s cyclical contraction has to go, and so it may be premature to sound the ‘boom-bust’ alarm.
Short-term cyclical issues aside, China is facing a number of severe structural issues. On the economic side, policy makers need to resolve how to manage the combination of exchange rate, capital flow, and monetary policies, how to foster well-governed financial markets that are free from excessive government intervention, and—as noted above—how to generate reliable economic statistics. On the political side, corruption continues to weaken the economy, as does the cognitive dissonance of a system in which citizens’ economic freedoms are not matched by their political freedoms.
China has incredible potential. Since the introduction of economic reforms in 1979, Chinese economic progress has been nothing short of astounding. During the last 35 years, China’s real gross domestic product has increased by an average of 10% per year. According to the World Bank, some 679 million Chinese were lifted out of extreme poverty from 1981 to 2010. And China is now the world’s largest economy, manufacturer, importer, exporter, and holder of foreign exchange reserves. Nonetheless, there are enough warning signs to suggest that difficult times may be ahead.
It’s time for China to make some new year’s resolutions.
Featured image credit: Lanterns China street by NattySttey. Public domain via Pixabay.