CHINA THE DWINDLING ECONOMY

  

Last couple of months have been a real nightmare for the Chinese lawmakers and global investors. Since June 12th 2015, the Shanghai Composite Index has been in a state of free fall, falling by as much as 31.2%, wiping out over $3 trillion dollars of the market value. It is to be noted that the Chinese stocks have more than doubled in value since last year till June 2015 despite a sluggish economy & weak corporate earnings. To put things in a perspective, in almost a month the Chinese stock markets have suffered an erosion in value roughly equivalent to the total output of world’s fourth largest economy, Germany!!!

At a time when global investor’s attention has been more or less remained on Greece and the future of European Union, the Chinese economy has been drifting away. If you compare the total Greek debt vis-a-vis the recent erosion is Chinese stock market value, it comes out as $350 billion against $3200 billion!!

Although Chinese government has taken a number of desperate measures. Trading had been halted in more than 1300 companies listed on Shanghai and Shenzhen stock exchanges. Various brokerage houses and funds have been provided a direct line of liquidity from the central back. In simple words, the Chinese central bank, PBOC created more money out of thin air and gave it to the people to buy stock to prop up their economy on papers! Now, when you make money out of nowhere and give it out to people to splurge, it always has repercussions. Below are the two graphs that give an idea of how Chinese have been artificially lowering the interest rates and providing cheap money to the ordinary Chinese citizens to invest in stock markets:

Let's first look at the interest rates, one year lending. In 1996, the rates were quite high at 11%, which made it quite expensive to borrow money. It is because when the government is not making monopoly money, then one will have to actually bid with other people to get resources. Those who could bid the most, get the resources to increase of the society. But when the government starts to make money out of thin air, then people bid up and the price of money goes down. So, they are crashing down these interests rates and you can see that happening quite regularly over the years.

The second graph is more important to watch as it gives an idea of how interest rates cut have affected the stock market movement in China over the last one year.

• November 21st 2014, PBOC or the Chinese Central bank, People's Bank of China cuts the interest rates and  the stock market went crazy.
• March 1st 2015, PBOC again cuts the interest rate and Shanghai Composite again sees a massive rally

So one thing is sure, the Chinese stock market crash that we witnesses is not so much a crash actually, but it is a correction. As someone has rightly said, "you want growth like puberty not growth like cancer". This graph depicts a topographic map of Mount Everest where the Chinese investors have died climbing it on their way to an illusionary peak.

All this leaves us to draw parallels to this recent Chinese crash with the wall street crash of 1929 in the US, which is both stark and remarkable. After experiencing phenomenal growth and extraordinary creation of wealth & resources, both economies, United States economy of 1929 and Chinese economy today are at similar stages in their economic life cycles. Booms seen in both the countries can be very easily explained by the monetary policy of their respective central banks which led to easy availability of cheap cash. Now, Even Ben Bernanke, former Fed Chairman has admitted that the 1929 crash was a result of the monetary policies of the Federal Reserve.  

There are a lot of things in stake. Like 1929 crash led to the collapse of other economies including Germany, which produced 'Fuhrer' Adolph Hitler and led to WW2, even this time stakes are equally high. Just to give an idea of that,

China has more than $4 trillion in foreign reserves, the US only has around $125 billion. Chinese citizens have a mind boggling $22 trillion dollar saved in personal savings while Americans only have around $615 billion, so it’s a huge mismatch. And this is why what happens in China has the ripple effects on the world economy. God forbid if China needs to start selling its US treasuries bond to cover any holes that it has in its income, that would cause a huge dislocation and send tremors across the world.

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