The great Chinese Dragon tumble on Monday led to a furore in
almost all the leading markets of the world with all of them ending in deep red.
The Shanghai Composite Index ended trade on Monday down 8.49 percent, after all
of the yearly gains were wiped out of the market. Let’s start decoding what led
to this Monday Mayhem.
A quick background…
In 35 years from 1979 to 2014, the Chinese economy has grown
by 10% per annum and doubled in size every 8 years, relative to the US economy.
The subsequent governments in China worked on “decollectivization” of
individual farm lands which helped improve agrarian productivity to help feed a
burgeoning city population. Then they set up innumerable micro and small
enterprises in the manufacturing sector and opened new industrial zones in
Pearl River Delta in South China (adjacent to Hong Kong and Macao) and in the
Fujian Province (close to Taiwan).
The Economic Boom
Gradually, foreign investments surged into China primarily
due to availability of cheap labour, and also due to the succession of Hong
Kong into Chinese mainland in 1997 and China’s subsequent entry into the WTO
also added to the cause. Chinese Government ensured competitiveness of Chinese
goods by repeated devaluation of its currency from 1.5 Yuan to 1 US$ in 1978,
to 4.8 Yuan to 1 US$ in 1990, to 8.3 Yuan in 1994, to 10 Yuan very recently.
One example of a successful manufacturing enterprise from China is Foxconn,
manufacturer of iPhone, which is now setting up its manufacturing units in
India.
The Problem starts
With a devalued currency and manufacturing glut, exports
surged to unprecedented levels. Over time, while manufacturing continued to
power ahead, unfortunately, the global demand and consumption of Chinese manufactures
hit a new low. China started experiencing a crisis of over accumulation; i.e
production far outstretches consumption both in the international and in the
domestic markets, especially in cement, steel, aluminum and shipbuilding.
The situation
deteriorates
The Chinese economy in 2007 found itself to be
uncoordinated, unbalanced and unsustainable. In 2009, thousands of companies
shut shop leaving 20 million workers unemployed. By the time it was 2013, there
were ample Government stimulus programs in place and shadow-banking networks
active. (It has been common practice
for investment banks to conduct many of their transactions in ways that do not
show up on their conventional balance sheet accounting and so are not visible
to regulators or unsophisticated investors.) Growth rates were upped, but it
left a toxic legacy. There was indebtedness all around, insufficient
consumption of manufactures, and to top it all the property bubble deflated in
2014. Central Government then encouraged investors to flood the stock market
with money, and by June 2015, the Stock Exchange had soared by 150%. But, since
this was in complete dissonance with the real economic situation, and with huge
numbers doing margin trading, it didn’t take long for the stock market to
crash, which it did on the 12th of June, 2015 and there was rout of
4 trillion $ of value from Chinese stocks. These developments in China will surely
have had repercussions all over the world and for a long time to come!
And, eventually
on 24 August, the worst fears of most of the world economists were realized
when the Shanghai market tanked and took all the major markets with it.
-Ms. Monica Mor
Senior Faculty, INLEAD
Courtesy- Google Images
Courtesy- Google Images
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