Chinese economy a work in progress

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China stock market decline graphicThe recent ructions in the Chinese stock market set off great consternation in global financial markets, but for the most part this was a display of ignorance.  

One of the reasons China’s influence on global markets has been so beneficial, since at least 2007, is that its economy and financial markets are so different. During the global financial crisis (GFC) of 2007-2008 that diversity was one of the factors that saved the global system.

It was a little like linking a series of supercomputers up with a 1980s Atari. The financial virus (mainly sparked by derivatives, financial instruments ‘derived’ from more conventional transactions) started to spread at lightning speed through the developed economy supercomputers.

But when it hit China’s more backward financial system, the ‘virus’ was not recognised. For one thing, China did not have derivatives and its banking system was still basically communist, so it was not as susceptible to the ructions occurring in the inter-bank lending market. Chinese authorities were able to respond more effectively than Western leaders, and that bought valuable time for the global system.

Almost a decade later, China is starting to dabble in derivatives and it is experiencing the volatility that goes with it. It is now allowing margin lending (borrowing most of the money to buy a security, such as shares) and short selling (betting that the future price will fall). Both are being blamed for the sudden fall in the stock market, which is a fair call. A financial journalist has been arrested and blamed. That is what you get when you ‘de-regulate’ financial markets (a nonsense, because they consist only of rules). Large scale gambling.

But China is still a long way from having Western style financial markets. It is closed on the capital account, so money is for the most part locked up in the economy and the banking system is mostly closed to outside influences. The stock market is nominally large, but is largely owned by the government. The Chinese market is only a tenth of Morgan Stanley Capital International (MSCI) developing economy index.

Crucially, China does not have a developed corporate bond market and, because of its large central government surpluses, it does not have a well developed public bond market, either. That leaves few options for Chinese savers. They can leave their savings in bank deposits but the returns are negligible, or negative, after inflation. They can buy property, but that market is overheated.

Private property rights are also fairly recent, so the market is nothing like property markets in developed economies. Over the last year they have turned to the stock market but that, too, is overheated. There are few avenues to legally invest offshore.

This structure is nothing like the markets in countries with more complex financial systems, such as Australia, America and Western Europe. Yet it has to be said that the simpler structure has served China well over the last two decades. The country has achieved sustained levels of economic growth that have never been seen before.

The conventional Western view is that this has been achieved despite the lack of sophistication in the financial system. But what if it is because of the lack of sophistication? There is certainly a case to be made that the extreme complexity of the Western financial markets, now being made worse by computerised high frequency trading that is making the markets gyrate wildly within a day, has been a near disaster. Western markets are still recovering from the GFC almost a decade later. Most Western economies have interest rates at or near zero in a desperate attempt to get liquidity back into the system.

In any event, China has control of more of its financial system and that is likely to be important as it enters a difficult transition period. Investment is about half of GDP, which is measure of the lack of savings options (surplus money may as well be invested if there is no other sound alternative). In developed economies investment is usually about a tenth of GDP; three quarters is consumption.

As the seasoned Asia-watcher Ken Courtis points out, the investment patterns are changing. Over the last three years the 'capital-intensive smoke stack industrial sector' was over 50 per cent of GDP. It has fallen to 42 per cent of GDP. Meanwhile, the service sector this year will be over half GDP.

China, in other words, is making the shift to being more like fully developed economies. But they might want to think twice before increasing the size of their financial services industry to developed economy levels (Finance is now Australia’s largest industry sector). China has done well by not allowing the finance industry gamblers to take over, as they have in Western markets. It would be a mistake to allow them in now.

David JamesDavid James is a business journalist with a PhD in English literature. He edits Personal Super Investor.

China stock market decline graphic by Shutterstock.


Topic tags: David James, economics, China, finance, GFC, derivatives



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Dear David - an interesting contribution on China's financial moves. But can I urge the greatest caution in using phrases like 'China has done well...'. To praise its efforts is simply to give support to the neo-liberal, capitalist, self-justificatory mantra that China has brought more out of poverty than ever before in history. But at what short- and long-term cost? There's no need for me to recite details of the massive soil, water, air etc.,damage done, the ongoing deadly health issues for millions of people. There had to have been another way. Can I urge you, and anyone else interested in the Chinese people's well-being, to read the detailed assessment of this damage, analysis of China's political nightmare, and more in the definitive article, 'China's Communist Capitalist ecological apocalypse' by Richard Smith, (Institute for Policy Research and Development, London) real-world economics review, issue no.71 (2015)
Len Puglisi | 14 September 2015

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