The Chinese markets declined precipitously today: the Shanghai composite index by 6.9 percent, the Shenzhen Composite by 8 percent, and the CSI 300 index by 7 percent. The reason for the decline is generally given as the pending release of controls on share trading by major institutions. This has locked up a large number of shares which should be released by the end of the week. The fear of increased supply, which was known to be coming, finally penetrated the Chinese markets, resulting in the crash and the triggering of mechanisms that suspended trading after this level of decline was reached.
It is important to bear in mind that the controls that are being lifted later this week were put in place in response to prior sharp declines in the Chinese markets. It is also important to understand that the Chinese markets do not play the same role in the Chinese system as Western markets. Western markets are a prime mechanism for business acquiring capital and given their breadth are a measure of the economy as a whole. That isn’t true in China, so this does not have the kind of broad impact as would be the case in the West.
At the same time, this decline is not insignificant by any means. First, there are many individuals as well as institutions involved in the markets and they just had their net worth contract by an average of about 7 percent. That is a lot of wealth destroyed. Even if it is more a casino than a bourse, a decline on this order can destroy a lot of demand for goods at a time when China’s economy is under heavy pressure from declining imports. So casino or not, an extended decline in the market will affect the economy.
But most important are the political consequences. The market decline indicates an underlying lack of confidence in the economy and in the state’s regulatory regime. If the only thing to prevent a financial panic is government regulations freezing the sale of some shares, the underlying fear is telling. The Chinese government is simultaneously increasingly repressive and conducting large-scale purges under the anti-corruption banner. At the same time it is trying to infuse confidence in the economy among the public. Unless this panic selling can be stopped, there will be some political impact. If the government responds by keeping controls in place, it may stop the selling, but it will cause the Chinese public to wonder about the status of the economy.
According to our model, China is in economic decline as it enters a period of lower growth and this will challenge the Chinese political system. We have already seen the Chinese government trying to maintain order in the face of deep unease. It is too early to say that this is a meltdown in the Chinese markets and it is understood that China’s markets do not function as Western markets do. Nevertheless, in a Eurasia undergoing massive instability for different reasons, the relative quiet in the Chinese economy just ended. The government will now try to get it under control before the panic spreads elsewhere. Plus, a 7 percent loss is no trivial matter.