China slowdown is no cause for global alarm
THE year started with an initially alarming turmoil in stock markets around the world. The Chinese stock market and the offshore Chinese currency market in Hong Kong were the twin epicentres of this financial scare. Although the slowdown of the Chinese economy is a popular explanation by most market commentators for the wild fluctuations in financial markets, I do not think that it is a convincing one. Firstly, the Chinese slowdown was not unexpected. Although the latest registered Chinese GDP growth is slightly lower than the average 7 per cent that China had announced as new normal a couple of years ago, it is still much higher than any major economy in the world, except India's. Also, firms like General Motors announced that they achieved record sales figures in China in 2015. What explains the turmoil in Chinese stock and currency markets, I believe, is due to a correction that is related to the three experiments with the financial markets.
In the first, the Chinese government encouraged, for political and economic purposes, leveraged retail investment in stock markets causing a huge bubble, especially in 2015. The second saw Chinese retail investors trust their government rather than their analytical capabilities to search for yield in the stock markets, whereas the authorities have so far failed to create new legitimate asset classes - both domestic and international. A third on stateowned and private corporations' bet on the continuous rise in the yuan's value against the dollar amidst low dollar interest rates. All three sectors in the Chinese economy are - theoretically and practically - under-developed in financial calculations. The Chinese economic development has so far prioritised the real economy by making finance serve it through a centrally planned banking system and stock market. The challenge now for authorities is to develop a financial system that suits an internationalising China with a growing services sector. And the challenge for the rest of the world is not to turn this Chinese search for a financial balance into a destabilising speculation for the likes of hedge funds.
An orderly internationalising Chinese economy and financial markets and currency are in the interest of the whole global economy. Chinese domestic stock markets are not directly open to international investment. Chinese companies do not borrow from international banks and therefore there is no contagion risk to the rest of the world from China's teething problems in finance. I believe the sharp declines in the stock markets in the US and Europe were due to the grim economic outlook for those economies. So the blame for the turmoil in the early days of 2016 should rest with the policymakers and private sector in the US, where the low oil price has exposed its energy sector and banks to new credit risks. In the EU, Italian banks especially have large amounts of bad debt that thwart the ECB's quantitative easing policies. With the end of credit expansion in China and monetary loosening in the US, the global economy has entered into an unpredictable period. The immediate focus is going to be whether China is going to be a new source of instability for global financial markets and whether it can control its monetary policies and its currency, which has just been included in the IMF's special drawing rights. The very first step that China has to take is to institutionalise a central bank that global players believe is independent of political interference. Such a central bank requires a governor who is a household name for the rest of the world and has excellent communicative skills with the markets. China, however, should not fall into the trap of a central bank-led economy like the US and Eurozone after the 2007 crisis. Creating a service economy at home and internationalising Chinese finance is not a monetary matter. An existential problem faces China - how to tame finance to serve its real economy at home and abroad. The Western financial system that China has far copied is not the right answer. Instead of seeing China as a threat to global financial stability, the world should collectively use China's internationalisation as an opportunity to build a safer global financial system for all.