The Chinese Economy

 

Will the Chinese Economy Collapse? Since I published the article, ‘The Hiccups of the Chinese Stock Exchange’, there have been dramatic changes to the Chinese economy. If you look at share prices, they have dropped by another 20%. On ‘Black Monday’ there was a huge drop in a single day which knocked stock markets around the world and they too lost value. So, could the whole Chinese economy collapse? If it did, what would be the impact on normal people (you and me)?

The Chinese government has taken measures to try and stabilise their economy. They have lowered interest rates and cut the exchange rate. (You will understand how that works from the article ‘Interesting Interest Rates’) However, will it work?

To answer this, we need to understand a little about China. Firstly, it is huge. Look at an atlas (okay, google maps). It owns a massive amount of land. Secondly, there are loads of Chinese people. Loads. This means that what China does is slightly different to the rest of the world, an elephant moves differently to an ant.

If we go back twenty-five years, the idea that China could totally collapse was a real possibility. Why? Well, have a look at what all those Chinese people do, how they live. In the past, when there were 1.1 billion people in China, 800 million of them lived on farms. They were subsistence farmers, surviving on what they could grow. Think about it, that was one sixth of the world’s population, living in rural China, dependent on their own piece of land for survival. This made for a very unstable country. If there had been a drought, for example, 800 million people would have up sticks and moved. Imagine if they had rioted! This would create something of a crowd control problem.

Now, that didn’t happen and since that time, China has been increasing industrial development and urbanising such that today under half of its population lives in rural communities. (That is still 10% of the world’s population but it is significantly less than it was.) This makes the country more stable, there are more safety nets if there is a disaster.

As an interesting aside, if you look at world poverty, China, through urbanisation, has done more to move more people out of poverty than any single aid agency. You might not agree with how that has been achieved but it still makes for an interesting fact.

So, if we go back to our original point, will China collapse, then no. A complete melt down now seems unlikely. Okay, but could it still have a serious wobble? Could they be heading for a massive recession? Could the Greece thing happen but on a hugely magnified scale? Could the growth of the last 15 years come to a grinding halt?

Well, let’s look for a minute at how that growth came about. Firstly, China has a stable government. Again, you might not like the way it runs the country, but it is stable and that is good. That government has incentivised the massive population so that they leave their little rural areas and move to the cities. They have encouraged people to start businesses, to be entrepreneurs. They have unlocked innovation and allowed huge growth. They have done this by largely ignoring: the environment, human rights, health and safety. You might think the costs are too high. But it worked. The Chinese economy grew very large very fast. At least, it worked in the short term. However, there are weaknesses.

The weakness can be seen if you take a train ride from Beijing to Shanghai. You will pass empty city after empty city. All the infra structure is in place, massive stations, sky scrapers, office blocks, housing, roads, electricity. But no people. They are like ghost towns. Why?

Well, the local governments have had a policy that “if we build it, they will come”. They have built cities and when they are complete, people have moved from the rural areas and opened business, run factories, made money. They have filled the cities with tax paying workers, that tax has been used to pay back the loans from the banks, everyone is happy. It fueled development on a huge scale. It was also like a lot of spinning plates, if you could keep them spinning it was great, if they start to slow down you have a problem. The plates are beginning to slow down.

If people stop coming to the empty cities, if they remain empty, then no one will pay tax, the local governments will default on their loans. Then the small banks will need help from the big banks. The big banks will need help from the government. In real terms, for real people, what would that mean?

In 2008, the UK had a banking crisis which led to a recession. People lost jobs, businesses stopped growing and so stopped recruiting (even good graduates could not find work anywhere, it was bit of a shock!) The housing market slumped, people had less money. It was an uncomfortable time, one we are still recovering from, but the country did not collapse. At the same time, in Ireland, they had a bigger banking crisis and there was a much bigger recession. Their economy collapsed and the IMF had to bail them out.

Now, my guess is that China will be more like the UK in recession than like Ireland. It has not, as a country, borrowed much from other countries, it is fairly self-sufficient. They do buy a lot of raw materials, which will impact the markets, some stock exchanges may have a dip. However, we will not see a disaster like Greece has seen. Which is good because on the scale that China is, that would be devastating.

Image

The Hiccups of the Chinese Stock Exchange

The Hiccups of the Chinese Stock Exchange

IMG_0702

     The Chinese economy is growing at 7% per year and has been doing so for a decade. It is a very healthy economy at the moment. Companies are doing well and China now has a good working stock exchange, so it is possible to buy shares in Chinese companies. So should we? Should we be taking advantage of the healthy Chinese economy and investing our money?

      We first need to understand about shares and the stock exchange. A stock exchange is simply the place where shares in companies are bought and sold. The average value of all the shares on the exchange tells you how companies are doing. If we look at the Chinese stock exchange, from July 2014 to May 2015, the average value of shares more than doubled in value. If you had invested £200 in July 2014, by the end of May 2015 it would have been worth over £500.

ImageSource: Bloomberg

     However, before you rush out to buy shares in a Chinese company, you need to know that today (July ’15) those same shares would be worth less than £400. The Chinese stock market is crashing. Why? What is happening? Their economy is growing steadily but their stock market seems to have hiccups – big jumps followed by big slumps.

     We first need to consider what actually decides the value of a share. Firstly, a share is part ownership of a company – a ‘share’ of the company. So if the company is doing well, the share should be worth more. So if you own 1% of the company (have a 1% share) and that company doubles its income in a year, then you will either receive your share of that profit in a dividend (a cheque in the mail) or your investment is worth more (you can sell it and make a profit.) So, if the Chinese companies are doing well (which they are) you would expect the shares to be also growing steadily in value.

      In the long term, this is likely to be true. The steady growth of the companies will be reflected in a steady overall increase in share values. However, in the short term it is more erratic. Why? What else influences share prices?

      The second influence on the value of prices is supply and demand. Confidence in the Chinese market pushes up prices of shares. (Refer back to the article on market places if you are unclear on this. Remember, it’s just like ebay. Something that is popular will go up in price.) Global confidence in the Chinese market pushes up share prices. The share prices might even be higher than the value of the company itself.

     An example of this (though not a Chinese one) is Uber. In London, only black cabs can be hailed. Regular taxis have to be prebooked. Uber has created an app whereby a customer wanting a taxi can ‘order’ one on their phone. Any taxi who is part of the Uber scheme can respond and pick up the customer. It links taxi drivers and passengers. Excellent idea. I predict the company will do well. Unfortunately for me, lots of other people also think it will do well. That has pushed up the price of its shares, because lots of people see it as a good investment and want to buy them. According to the share price, Uber is worth twice as much as Sainsburys (though Sainsburys is probably worth a lot more as a company.) If I want to make money on the stock exchange, I need to be ‘ahead of the pack’. When everyone notices the same trend, it pushes up the price of shares, which lowers the likely profit from a short term investment.

     Now, the Chinese stock market is unusual because the overwhelming majority of shares are owned by small time Chinese investors. It is a culture that likes to gamble. The share holders are not interested in long term investment, they want short term profit.

      The Chinese stock market is very new (has grown up in the last five years) so people have not really seen any big ‘crashes’. It is seen as a safe bet. This is a bit like when we bought our first house. We had only ever experienced house prices going up, we assumed that a house was a ‘safe’ investment. It was something of a shock when houses prices plummeted at the end of the 80s.

      At the moment, small time investors see the Chinese stock market as a ‘safe’ investment. A lot of people are investing in, gambling on, the stock exchange. The share prices have become driven by rumour and speculation as people try to predict the future value of companies. The stock market has become more linked to crowd behaviour and less to the real value of companies. This explains the hiccups.