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Many people have an outdated notion of the quintessential Chinese factory, believing that they all just produce dolls, toy guns, cheap clothes or shoes.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.

The information in this report was compiled by the staff at City National Bank from data and sources believed to be reliable but City National Bank makes no representation as to the accuracy or completeness of the information. The opinions expressed, together with any estimate or projection given, constitute the judgment of the author as of the date of the report. City National Bank has no obligation to update, modify or amend this report or to otherwise notify a reader in the event any information stated, opinion expressed, matter discussed, estimate or projection changes or is determined to be inaccurate. This report is intended to be a source of general information. It is not to be construed as an offer, or solicitation of an offer, to buy or sell any financial instrument. It should not be relied upon as specific investment advice directed to the reader’s specific investment objectives. Any financial instrument discussed in this report may not be suitable for the reader. Each reader must make his or her own investment decision, using an independent advisor if prudent, based on his or her own investment objective and financial situation. Prices and availability of financial instruments are subject to change without notice. Financial instruments denominated in a foreign currency are subject to exchange rate risk in addition to the risk of the investment. City National Bank (and its clients or associated persons) may, at times, engage in transactions in a manner inconsistent with this report and, with respect to particular securities and financial instruments discussed, may buy from or sell to clients or others on a principal basis. Past performance is not necessarily an indication of future results. This report may not be reproduced, distributed or further published by any person without the written consent of City National Bank. Please cite source when quoting.