The Great Fall of China?

~ By Mallika Iyer

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Erik de Castro – Reuters

When countries face an issue or two they are generally resolved by quick inter mediation however, mass systemic disturbances can cause well-established social, financial and political structures to collapse. Although China hasn’t reached the latter stage yet, the present circumstances must be addressed immediately or the world could face a massive economic crisis triggered by the Asian dragon.

In the past twenty years, China’s unprecedented rise has been too smooth a journey. The country has paved its path to success through its technological advancements, cheap manufacturing units, strategic relations with key oil producing African Nations, and the fact that it holds more US debt than any other country. However, towards the second half of 2015, the world witnessed significant defaults in the China Model and the problems this caused.

In the past 30 years, the Chinese economy has continuously boasted of high growth rates. While experts were predicting slowing growth rates this year, the shock really hit when on 24th August 2015, London’s FTSE 100 shed approximately 74 billion pounds in a mater of hours following massive sell-offs in the Shanghai Composite Index (which had already fallen 30% between mid-June and Early July when investors who had inflated the stock market rates faced margin calls from their brokers and were subsequently forced to sell). This fall in investor confidence coupled with a slow response from the government (which, at one point even threatened to imprison traders engaging in massive short-selling) led to Black Monday on 24th August, a single day in which the Shanghai index fell by about 8.5%, its biggest fall since 2007. But, it must be noted that a stock market crash, however brutal, can have minimized damages if authorities take the necessary measures at the appropriate time.

The fact is Chinese investors themselves are facing massive debt problems. Chinese borrowers are taking on debt worth approximately $1.2 trillion to repay interest on their existing obligations. This vicious cycle of incurring debt to repay interest on existing debt significantly raises the risk of default once interest payments become too huge to ignore and lenders refuse to give further loans. Moreover, the local government currently has approximately 15 trillion Yuan of debt it has to repay, with another 8.5 trillion Yuan stuck in contingent liabilities.

In addition, China has many economic partnerships and relationships with other countries. Its slowing economy is impacting different sectors in different countries.

Though UK companies were adversely impacted by the credit crunch in China, investors losing confidence in the Yuan sought different markets and asset classes to park their wealth. To an extent, real estate in UK became a popular choice though by no means did it witness a tremendous rise as compared to Vancouver where a buying spree by Chinese and Hong Kong businessmen caused double digits rise in house rates. As the Renminbi (Yuan) loses value, it becomes safer for Chinese citizens to invest in foreign assets. However, the Chinese law restricts its citizens from transferring more than $50,000 per year in foreign exchange. But where there’s demand, there’s supply. A number of illegal underground banks emerged, providing facilities for transferring money overseas. As of December 2015, Chinese authorities arrested more than a hundred bankers involved in these underground activities, which resulted in the transfer of approximately 800 billion Renminbi to foreign currencies. Illegal transfers such as this further disrupt the foreign exchange management system of a country, causing financial and capital market disorder and adding to the already existing woes.

U.S. markets could be negatively impacted in the future as investors from Chinese states may find U.S. stocks, commodities and bonds to be a more attractive option. Though this would be a positive cash flow for the United States, it could strengthen the dollar even further thus causing exports from the U.S. to be relatively more expensive and thus less competitive.

As far as commodities go we are observing lower prices due to lower demand as Chinese exporters are finding alternative markets to ship them to. Countries like India are being forced to put curbs on steel imports, owing to a tide of cheap Chinese shipments, thus creating fear in the domestic markets of the importing countries.

Moreover, the fall in Chinese demand is causing prices to decrease; for instance, copper prices are resonating the low price levels of December 2003 as demand for electrical appliances is falling in China. This has even led to major copper smelters proposing output cuts in 2016 because lower production and output inevitably results in job cuts, which can be a cause of panic across the markets.

Being the world’s second largest economy, the biggest manufacturing nation and a global exporter, any domestic crisis in China is likely to spread globally. While it is too early to say if we would witness a catastrophe like the 2008 U.S. financial crisis, which led to a global meltdown, we still need to be prepared for adverse effects; be it job-cuts, falling commodity prices or rising real-estate prices in other parts of the world.

(Mallika Iyer studies at the London School of Economics , and is a passionate writer .)

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