Wednesday, 9 September 2015

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Impact of Chinese stock market crash

What is the Impact of Chinese stock market crash?
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In recent months, the Chinese stock market has been very volatile, with sharp drops in prices since last July. On August 24th, share prices fell 9% – one of the biggest single day falls. People fear this is the bursting of the Chinese stock market bubble which could have serious effects on the global economy.

Possible effects of a Chinese stock market crash include

1. Reduced exports

In recent years, China has seen a rise in consumer spending. Consumer spending has been growing at 10% a year. This is an important source of export demand for many Western companies, who see China and Asia as a major source of growth. Some brands like Burberry and Yum! Foods have carved out a niche in Chinese markets.

A fall in share prices will reduce the wealth of Chinese investors who have purchased shares. Perhaps more importantly the 'headline news' falls will have an adverse impact on Chinese consumer confidence. Worries over share prices (combined with falling house prices and  political uncertainty) could derail this growth in consumer spending, leading to less export demand. Given weak economic growth in the Eurozone and the US, a fall in exports to China could be another factor in holding back growth and triggering another slow down.

2. Global confidence

Dramatic falls in share prices raise the spectre of recent crisis, such as the 2008 credit crunch. Falls in Chinese stock markets, tend to be mirrored in other stock markets, causing global ripples of lost confidence. This uncertainty and volatility can be a factor in discouraging investment and spending, another factor in causing a potential global economic slowdown.

3. Rising dollar

Another factor is that instability in China could cause investors to seek safe havens for their funds. Rather than hold Chinese and Asian shares, they may look to the US, where there appears to be greater stability. A rise in demand for US shares and bonds will push up the value of the dollar. This appreciation in the dollar will increase the price of US exports and lead to lower export sales.

4. Falling commodity prices

If the Chinese economy slows down, there will be a fall in demand for global commodities, such as oil, gas and metals. This fall in commodity prices will reduce export revenues for commodity producers, such as Canada, Australia, OPEC and African countries.

On the other hand, it has benefits for Western consumers who will benefit from cheaper oil and commodity prices.

Evaluation

Limited importance of Chinese stock market. The floating value of the Chinese stock market is only a third of GDP – compared to 100% of GDP in countries like US and UK. Only 15% of household financial assets are invested in shares. (Economist) This means that falling share prices don't have a strong link to consumer spending (just as the rapid rise in share prices didn't cause a boom in spending.) Of more concern to Chinese consumers is the fall in house prices. The fall in house prices may not make headline news, but more wealth is tied up in property than share prices.
Share price falls often fail to predict serious crashes. As the joke goes stock markets have correctly predicted 10 out of the last 2 recessions. Or as Larry Summers states.
As in August 1997, 1998, 2007 and 2008 we could be in the early stage of a very serious situation.

— Lawrence H. Summers (@LHSummers) August 24, 2015

Share prices rose a lot before crash. The other side of the 30% fall in share prices is the very rapid rise in prices previously. Share prices are still higher than at the start of the year.
Benefits of slow down in commodity price rises. At the start of the 2008 recession, developed economies were hit by rising oil prices as continued growth in China caused rising oil prices – despite western recessions. The flip side is that falling oil and commodity prices will give an effective boost in discretionary income to Western economies.
Lower inflation. Falling commodity prices, a rising dollar and lower export growth will help reduce any inflationary pressure in the West (though inflation is already low, and deflation could be more of a concern). For the US, a rising dollar and lower inflation could be a factor in delaying the long-predicted rise in interest rates.
Conclusion

On its own the Chinese stock market has little direct impact on Western economies. However, falling share prices could be a signal of a wider malaise in the Chinese economy – such as excess levels of borrowing, and a bust in the property market. A major slow down in the Chinese economy would have a serious impact on the global economy.

But despite the size of the Chinese economy, the global economy is not reliant on Chinese consumer spending; the global economy is increasingly diversified. However, if a Chinese slow down is mirrored by other Asian economies, it could be another factor in holding back growth.

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