Has China replaced the US as our financial bellwether?
What happens in China affects the world. It may not be as important as the US – yet. But if you are wondering about the trigger for the current stock market weakness in the UK, Europe and to a lesser extent the US, start looking there.
Back in January the most important index, the Shanghai Composite, hit a two-year peak. Since then it has fallen by 27 per cent. The smaller company Shenzhen, which has been more volatile, has fallen by 34 per cent in the same period. Last Friday the collapse of prices had become so serious that the three most senior financial officials in the country intervened with statements of support.
The governor of the central bank, the People’s Bank of China, Yi Gang, the chairman of the China
Securities Regulatory Commission, Liu Shiyu, and the head of the newly merged banking and insurance regular, Guo Shuqing, all made various policy changes designed to underpin share prices. These are three of the top dozen of the Chinese oligarchy that runs the country. All are thoughtful, measured and competent.
Unsurprisingly on this news, share prices shot up. Indeed they had their best day for three years. This week, however, things have been more unsettled, with prices fading a bit. Confidence clearly is still extremely fragile.
What’s happening? We are too close to events to be able make any definitive judgement but I think two things have come together.
One is a general economic slowdown which in turn is a reaction to excessive credit growth. The Chinese economy has been floated along on a flood of cheap money, with the result that a lot of loans have been made that will not be repaid and a lot of infrastructure has been built that is beyond current needs. The bridge/tunnel from Hong Kong to Macau that opened this week is just one high-profile example of the latter.
In response, access credit is being tightened. Maybe it was over-tightened, but the outcome has been a slowing of demand. The economy is still growing strongly, though maybe not as fast as the 6.5 per cent reported for the third quarter. That, by the way, was the lowest GDP growth for nine years, though by most standards it would seem just fine. At any rate the authorities are trying to find ways of boosting demand and we will see how that transpires.
In about four years’ time China will have become a larger economy than the EU, though it will still be smaller than the US until the late 2020s
The other factor is the trade war with the US. This is hitting demand in China, whereas in the US it seems to have had very little adverse impact. But it is also hurting companies that export to China, particularly in Europe.
It is hard to game a trade war – to figure out who will be the winners and who the losers – because we have very little recent experience of one. We know that trade restrictions in the 1930s exacerbated the global depression, but that was a long time ago. Until a few weeks ago the US markets seemed to be cantering along regardless. If there was any sign of contagion, it was Europe that seemed to be suffering, for example with German exports to China weakening.
This view that the US continues to grow strongly while things slow in Europe has just been supported by the new purchasing manager indices out today. Capital Economics puts it this way: “Preliminary Markit PMIs provide tentative evidence that the eurozone economy will lag behind advanced-economy peers in Q4, as growth holds up better in the US and Japan.”
These are only one set of figures, and we have enough experience of data being misleading not to read too much into them. But Europe does seem to have been caught in the US/China crossfire.
If this line of argument is right, then it will indeed have been Chinese financial markets that have given the first warnings of stock market weakness in Europe and the UK. That is a first. Chinese shares have shot up and down in the past and these movements have had zero impact on our markets. Now they cannot be ignored. Looking ahead this influence will increase. In about four years’ time China will have become a larger economy than the EU, though it will still be smaller than the US until the late 2020s.
And now? Well let’s see what the Chinese markets do. I’m reasonably confident the authorities will prevent a total collapse of prices, but a downward slither would be harder to check. The big message, though, is that whereas even a couple of years ago if you wanted to see what might happen to British or European share prices you looked at Wall Street. Now you have to look at Shanghai too.