China confronts continuing economic turmoil

By Peter Symonds
11 September 2015

Chinese share markets remain volatile despite a series of government announcements aimed at reassuring investors and stabilising share prices. The benchmark Shanghai Composite Index fell on Monday by 2.5 percent, even though the China’s central bank governor Zhou Xiaochuan told last weekend’s G20 meeting that “the correction in the stock market is already mostly over.”

The share market bounced back by 2.9 percent on Tuesday and rose again on Wednesday after the Chinese government altered dividend taxes to favour long-term investors and the stock exchanges proposed a “circuit breaker” to limit the wild swings of recent months.

In another bid to calm the financial markets, China’s Finance Ministry announced on Wednesday that the government would take further steps to strengthen fiscal policy, boost infrastructure spending and speed up tax reform, amid growing concerns about the country’s slowing economy. Yet share prices fell again by 1.4 percent yesterday.

These steps all point to a degree of desperation in Chinese ruling circles. The Shanghai Composite Index has plunged by 40 percent since it hit a high in June, wiping $US5 trillion in value off the mainland share markets.

The government tried to stem the falls, banning large investors from selling stock, stopping initial public offerings and restricting short selling. The Chinese Securities Regulatory Commission, which oversees the country’s share markets, also orchestrated the buying of shares, using cash supplied by the central bank. The actual buying was mainly conducted by the “National Team”—a grouping of state-backed investors, brokerages and funds operating on the government’s behalf.

Goldman Sachs estimates that the government has spent 1.5 trillion yuan, or $US236 billion, since mid-June in propping up share prices, including 600 billion yuan in August alone. The overall spending amounts to 3.5 percent of the value of all stocks in China.

Beijing has also initiated a police crackdown, with officers specialising in economic crimes making inspections of investment funds and brokerages in collaboration with agents from the national security regulator. In late August, eight executives at the state-owned Citic Securities, China’s largest brokerage firm and investment bank, were arrested on suspicion of insider trading.

The government will no doubt exploit such arrests to deflect attention from its role in promoting the frenzied share speculation that drove the market up by 150 percent in the 12 months to June. Having all but abandoned its socialistic posturing, the leadership has rested on its claims to be reliable economic managers presiding over an expansion of jobs and living standards. The share market rout, along with evidence of a marked slowdown in the real economy, is politically weakening the regime.

The government is also under siege on another economic front, with a large fall in the country’s foreign reserves as capital flowed out of China. After hitting a high of about $US4 trillion last year, Citigroup estimates that Chinese reserves have fallen to less than $3.7 trillion and will drop to $3.3 trillion by the end of the year. Currency outflows hit a record $48 billion in July. The prospect of an interest rate rise in the United States could accelerate capital flight from China.

The government has also ordered a tightening up of controls on currency exchange, which is restricted both for individuals and businesses but often operates through illegal money transfer agents. The central bank has been forced to spend up to an estimated $200 billion to prop up the currency since the August 11 devaluation of the yuan.

While Chinese foreign currency reserves are still large by international standards, concerns are being raised about the global implications. Deutsche Bank currency strategist George Saravelos told the Financial Times: “It is neither the sell-off in Chinese stocks nor weakness in the currency that matters most. It is what is happening to China’s FX reserves and what this means for global liquidity. The People’s Bank of China’s actions are equivalent to an unwind of QE or, in other words, Quantitative Tightening.”

In a comment entitled, “China risks an economic discontinuity,” Financial Times columnist Martin Wolf countered analysts who played down the significance of the stock market turmoil by asserting that China’s real economy, while slowing, was still strong.

“Market turmoil is not irrelevant,” Wolf wrote. “It matters that Beijing has spent $200bn on a failed attempt to prop up the stock market and that foreign exchange reserves fell by $315bn in the year to July 2015. It matters, too, that a search for scapegoats is in train. These are indicators of capital flight and policymaker panic. They tell us about confidence—or the lack of it.”

Wolf focussed, however, on the wider problems facing the Chinese economy that, he declared, “may prove huge.” He warned of a potential crisis. “There are at least three reasons why China’s growth might suffer a discontinuity: the current pattern is unsustainable; the debt overhang is large; and dealing with these challenges creates risks of a sharp collapse in demand,” he stated.

The latest economic data all provide evidence of a downturn, especially in manufacturing and exports. Trade figures showed a 5.5 percent drop in exports in dollar terms last month as compared to a year earlier, contributing to an overall decline of 1.4 percent for the first eight months of the year.

China maintained a sizeable trade surplus only due to an even steeper decline in imports of 14 percent by value—the 10th successive monthly fall. While the continuing drop in commodity prices played a role, the volumes of imports like coal, iron ore, copper and aluminium also dropped, indicating a decline in manufacturing activity and housing construction. Last week, the official manufacturing purchasing managers index for August was reported as 49.7. Any number below 50 indicates a contraction.

This week, China revised its growth rate for 2014 marginally from 7.4 to 7.3 percent. But many analysts question these figures, as well as the official growth target of 7 percent for 2015, and suggest significantly lower estimates.

Following the 2008 global financial crisis, the Chinese government unleashed a flood of cheap credit and spent liberally on stimulus measures in a bid to prop up the economy. Those measures failed to stimulate productive activity, however. They largely fuelled a frenzy of speculation in property, then in shares. Those bubbles are now unraveling, raising questions about the sustainability of economic growth and concerns over the mountains of debt accumulated by local and regional governments in particular.

The nostrum propagated by the Chinese regime, along with the International Monetary Fund, World Bank and a host of economic commentators, is that the country is undergoing a natural progression from an export-oriented economy to one based on domestic consumption.

This analysis, however, falsely abstracts China from the global economy, which has been decisive in its growth as the world’s chief cheap labour platform. Any attempt to refocus the Chinese economy on domestic consumption would likely lead to higher wages, making it less competitive as a manufacturing hub. Already, other Asian countries with lower wages, such as Vietnam and Bangladesh, are attracting a greater share of investment.

A “discontinuity” in China’s growth has far-reaching ramifications, not only economically but politically. The official growth rate is already well below the 8 percent level that was widely held to be necessary to sustain employment and prevent social unrest. A further drop, under conditions of widening social inequality, threatens to unleash upheavals by working people that would profoundly destabilise the entire regime.

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