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Chinese economy a work in progress

  • 14 September 2015

The 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