So we are back to China – clearly the singular focus of importance in the global economy this week. Global equity markets nosedived Monday due to concerns about China’s slowing economy and troubled stock market – and little hope for solutions.
But we believe it is possible to track the source of this week’s market earthquake to an epicenter that has quietly seen a radical transformation – the typical Chinese industrial factory.
Many people have an outdated notion of the quintessential Chinese factory, believing that they all just produce dolls, toy guns, cheap clothes or shoes. While those factories still exist, what China has done recently is invest in industrial infrastructure with factories that make high value, more technologically advanced products. This has meant a significant growth in wages for workers, but less profits for the companies.
Partly to fund this economic seismic shift, China allowed a tremendous amount of debt. In fact, one-third of all the global debt created in the world since 2007 occurred in China. As the debt has gotten too big, funding has turned to equity, which explains why the Chinese government allowed so many measures to encourage stock market speculation with margin trading and fewer regulations.
The effect was predictable as the Shanghai Composite shot up 150% from June 2014 to June this year. But those lofty valuations were susceptible to a fall. Since June, the Shanghai index has lost nearly half of its gains from the previous 12 months.
So where do we go from here?
My View: There is no short term answer to what is a multi-year restructuring of the Chinese economy. China needs to get used to slower growth until these issues are worked through, and the rest of the world needs to understand that volatility is unavoidable.
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