What should be made of the ructions in global financial markets that have been dominating the news headlines over the past few days? Despite some of the more inflammatory analysis, rational examination suggests this is a correction for China’s economy rather than a true crisis and the end result could leave it in better shape than before.
While it is clear China is undergoing a significant fall in sharemarket prices – the Shanghai Composite, China’s benchmark index, is down 40 per cent since June 12 and continued to fall sharply yesterday – it seems equally clear that global markets have overreacted to what is taking place.
Several factors have exacerbated the effect on global markets of this Chinese correction, including the opacity of the country’s economic and monetary policy and the hybrid nature of its economy, which features a sometimes awkward pairing of both the free market and the command economy that once prevailed.
It is instructive to look at the global reactions to the Chinese government’s new policy of allowing the yuan to trade in a range roughly 3 per cent below its previous target. That, combined with the fall in Chinese share prices, helped drive the sell-off in global markets. But compare the effect of that devaluation policy to global markets’ far more restrained response to the steady erosion of the euro’s value, which has dropped 10 times as much over the past year. The clarity – or opacity – of the factors driving each one go a long way to explain the distinctly different reactions.
There are also good reasons to believe that this will be good for the Chinese economy in the long run because a fall in the yuan will give China’s manufacturers, the suppliers of the world’s goods, lower costs. This will result in lower prices for manufactured products that in turn ought to help increase exports overall, with more attractive prices providing an incentive for other global economies to buy Chinese goods.
Equally, there are reasons to believe that the falls in global stock markets over the past few days will be corrected relatively quickly. A further ramification seems to be a much lower chance that the US Federal Reserve’s anticipated interest rate hike, once projected to occur as soon as next month, will take place before March next year. The take-home message from all this is that the sky isn’t falling, despite some of the more vocal reactions to the events of this week.