China and the stock market

The writer is a freelance contributor.
Jim Chanos is a famous figure in American financial circles. He had rightly predicted the fall in the energy company, Enron, when almost everybody else was predicting a bright future for it. It turned out that its accounting numbers were fudged.
The same Chanos recalls being stunned when, in 2009, a presentation on China revealed a massive 5.6 billion acres of land under development. Like Enron, the numbers just didn’t match up. The majority of the investment was in the form of debt. This was reminiscent of circumstances preceding the great recession, of which an inflated real-estate sector was such a substantial part.
Chanos also noted that a substantial amount of construction was in the form of high-end apartments costing around $100,000, while the average Chinese income at that time was not more than $10,000. Forward to 2015 and ghost towns are now a common feature of the Chinese landscape. These are complemented by a plethora of troubled banks (which had given out generous loans).
This only serves to show that all is not well on the Chinese economic scene. The recent slump in the Chinese stock market and the accompanying fears of a slowdown that sent shivers around the globe are a manifestation of this. Other stock markets, including that of Pakistan, also showed a declining trend. In the face of these fears, the Chinese central bank stepped in swiftly to halt the slide, using the standard remedy of lowering interest rates to spur economic activity. But fear and uncertainty still grip the global markets.
Stock market movements are a closely watched barometer of economic performance. Their importance owes primarily to economic history. The greatest recorded economic catastrophe in human history, the Great Depression, was set off by a stock market crash. Although the dynamics and working of economies are different now, swings in stock market can still lead to substantial variations in economic performance. This is a classic case of the effect of a predominantly speculative phenomenon on real economic activity.
The reasons are complex to narrate here, and can be hard to understand for a non-economist. Suffice to say that the end manifestation of a negative stock market trend is in the form of decreased economy-wide demand (known as aggregate demand). This ultimately dents the growth of GDP.
Back to the question of why China’s stock market slump is so worrying for the world. There are a few probable answers, starting with the state of the global economy. The economies of the western world have yet to recover properly from the effects of the ‘great recession’ that has afflicted its economies since 2008. Despite the best efforts of policymakers, the performance of these economies has been rather lukewarm. Their underperforming economies imply an underperforming global economy. Any semblance of recovery has been dented by events like the Greek debt crisis and the Libor scandal.
The global economy, at this moment, is in a delicate balancing act. The last thing it needs is bad news from China, whose economic performance has acted as a bulwark against further shock to global economic growth prospects. Any decline in Chinese economic growth numbers could, in the most pessimistic of scenarios, plunge the global economy into a depression.
That would be a catastrophe that humanity can ill-afford. Though the chances of that happening are remote, policymakers would do well to remember that events like stock market crashes and bank runs are sudden and hard to predict. Nobody could predict the great depression nor the great recession. But they happened – within days.
China now has the distinction of being the second largest economy of the world. With this distinction also comes the development of China as the second largest importer (its imports are approximately $2 trillion). The relatively poor performance of the global economy owes primarily to lower aggregate demand in lieu of the recession. This depressed demand explains the overall trend of lower inflation, including that of Pakistan.
If the Chinese economy also starts underperforming, global demand will slack further, setting into motion a chain reaction that could prove disastrous. Also take into account the nature of how information flow in a closely intertwined global economic system can cause economic fluctuations. That’s why jitters in the Chinese stock market are being felt elsewhere.
As mentioned above, China’s stellar economic performance has served as a counter to the poor economic performance in the western world. But the Chinese stock slump has aroused suspicions that the option of this balancing act may not be available anymore. For countries whose exports depend substantially upon Chinese demand, this is bad news. This makes the anxiety felt globally more understandable.
There are a few more issues regarding this scenario. One revolves around the dearly held misconception that the Chinese economy represents a case of a communist economy outperforming capitalist western economies. Nothing could be farther from the truth. If the Chinese economy were a communist economy, there would not have been a central bank (a capitalist invention) tinkering with interest rates to stimulate the economy. The Chinese economy, in fact, is a classic example of state-led capitalism where one party administers measures for economic growth; his has been the case since the economic reforms of 1979.
Another important issue is the setting of growth targets. Many people don’t realise that by setting targets, countries may well fall into a debt pit. Pursuing economic growth is not a free lunch. This is true of all economies and all countries. The Chinese planners have been setting up high economic growth targets for many years now. Thanks to their very high savings, they have been able to maintain the expenditure that props up its economic performance. But in doing so, it has racked up a debt of $28 trillion.
What does this all hold for Pakistan? In reality, the faltering predicament of the global economy may even be a boon to Pakistan. Almost 70 years into our independence, our economic performance is still heavily dependent upon what happens outside of Pakistan.
Just take the recent example of lower oil prices, which has proved to be a blessing in disguise for our economic managers. It has staved off the pressure on our economic Achilles’ heel – the current account. Further decline in global demand would mean further improvement in Pakistan’s current account situation, and would create further fiscal space. So in this case, what’s unfortunate for the global community turns out to be lucky for Pakistan.
But what about the all-important CPEC, you may ask. Well, don’t worry. It’s a $46.5 billion project, which is a gigantic amount for us but peanuts for the Chinese. The only worry for Pakistanis should be that they will be the ones ultimately footing the $46.5 billion bill.
How so? The $46.5 billion is not coming in the form of a generous gift from the Chinese (the Americans are much more generous in this regard). It’s in the form of loans that Chinese banks will provide to Chinese companies for investing in Pakistan. The investing companies have to return that loan from their commercial profits made in Pakistan.
So if you are a non-Pakistani, you should be worried a bit. But if you are a Pakistani, sleep tight for the moment and celebrate the lower oil prices.
Email: shahid.mohmand@gmail.com
Twitter: ShahidMohmand79