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Black Monday Q&A: why are markets around the world collapsing? China's Black Monday explained: What is it – and how will it affect you?
(35 minutes later)
“China” is the single most common answer given by those who work in financial markets. They talk about fears of a sharp deceleration in the world’s second largest economy. They see these fears triggering a wave of panic selling from investors around the globe.“China” is the single most common answer given by those who work in financial markets. They talk about fears of a sharp deceleration in the world’s second largest economy. They see these fears triggering a wave of panic selling from investors around the globe.
Other culprits cited are the collapsing oil price and the prospect of an imminent hike in interest rates by the America’s central bank, the Federal Reserve. But those latter factors are both related to the China story.Other culprits cited are the collapsing oil price and the prospect of an imminent hike in interest rates by the America’s central bank, the Federal Reserve. But those latter factors are both related to the China story.
An increase in US interest rates will hurt Chinese growth by sucking capital out of China, further hitting growth there. And China is a big oil importer. If its economy slows it will need to buy oil, meaning the oil price would fall.An increase in US interest rates will hurt Chinese growth by sucking capital out of China, further hitting growth there. And China is a big oil importer. If its economy slows it will need to buy oil, meaning the oil price would fall.
Not really. The recent slump in Chinese shares has certainly been brutal. The Shanghai Composite Index is now down by around 60 per cent since June. The FTSE100 index of leading UK shares has taken a battering along with the rest of the world’s stock markets. And yet most UK forecasters expect our own economy to keep growing at a reasonable pace this year. The CBI today forecast 2.6 per cent GDP growth. That’s down from the 3 per cent in 2014 but still quite strong. If the economy grows at that pace wages and living standards for most Britons should continue to grow too.
Yet this is merely giving back some of the spectacular gains in share prices made over the past year. Many of the companies listed on the FTSE100 are global multinationals, whose fortunes are linked to the world economy, not the UK’s. The CBI and other forecasters think trade won’t help the UK grow this year. But while they think that exports will be disappointing they also think that domestic household spending and business investment will take up the slack and keep the wheels of the UK economy turning. They could, of course, be wrong though.
After several years of going sideways Chinese stock prices exploded around the middle of 2014, shooting up by 150 per cent in just 12 months. Even with the falls of the last two months the share index is still up 60 per cent on its level in June 2014. It’s not clear what put a rocket under Chinese stocks  but it seems to have been related to easier credit becoming available for small investors. These are the crucial players. Anyone who has their pension invested in the stock market will have taken a big hit to the paper wealth in recent days. But that need not matter if your planned retirement is several decades away. There is plenty of time for the markets to recover. Those who are close to retirement will probably have been advised to shift their pension portfolios mainly into cash or bonds – meaning that the equity collapse shouldn’t have hit them very hard.
Small individual investors make up around 80 per cent of the Chinese stock market far bigger than their share of stock markets in developed countries where institutional investors such as pension funds and insurance companies are dominant. And small investors are more prone to panic. Beijing is grappling with the end of a massive credit cycle. It managed to pump up its domestic growth rate in the global financial crisis by ordering its banks to extend a huge amount of credit to property companies. It was one of the biggest explosions of borrowing and investment spending ever seen in a single country in history. But the Chinese authorities are afraid that creating even more debt in this way could lead to a domestic financial collapse, or terrible domestic economic distortions. They are slowing the pace of credit growth and investment and trying to shift the economy into new sources of growth such as consumer spending. As they attempt this pivot, the country’s growth rate is, inevitably, slowing. The great danger is that without credit-fuelled investment the economy will slow too quickly and China will experience the “hard landing” than some economists have been dreading for many years now.
In any case, the correlations between Chinese stock market and Chinese GDP growth are weak. Just because shares tank it doesn’t follow that growth will too. There was a spectacular Chinese stock market bust in 2007, when equities fell almost 70 per cent over the next year. But throughout that period GDP growth actually accelerated. A slowdown in China will hit demand for oil, reducing prices. But there is also a separate depressing factor, namely a glut of supply too. America shale oil and gas producers have brought huge volumes of new energy supplies to the market in recent years. And Iran is promising to step up sales production after Tehran’s recent nuclear deal with the US. The price of a barrel of oil hit just $45 yesterday for the first time in six years. This is helping to hammer the prices of oil companies.
The concern is the slowing of the real Chinese economy. China is a huge economy, second only in size to the United States. And as an emerging economy it contributes a huge amount to global growth. Indeed, it is forecast by the International Monetary Fund to be the biggest single national contributor to global growth over the coming five years. Greece has been the dog that did not bark in this markets meltdown. Its Syriza government last month capitulated to the demands of the country’s creditors and agreed to imposed more domestic fiscal austerity. This removed the possibility of a “Grexit” and means investors in European markets were able relax. The Greek prime minister, Alexis Tsipras, did resign and call new elections last week. But very few analysts are expecting the Athens government to fall and for a new European financial crisis to break out. Again, though, they could be wrong.
If China slows down, that inevitably impacts on the entire global economy. Anyone who exports to China will take a hit. Many market participants are expecting one or more central banks to ride to the rescue in the near future to help restore confidence. This could take the form of action from the Chinese central bank to pump up growth by making it easier for Chinese banks to lend money to companies. Alternatively, the Federal Reserve may get cold feet and delay its first interest rise, which would also boost confidence. It’s also possible that stocks could bounce back in the coming days. Many traders are on holiday in August meaning trading volumes are relatively thin. In these markets changes in sentiment tend to have a much bigger herding effect. It’s possible that when more traders return they may take more sanguine view of the prospects of companies that make up the global indices and prices may recover.
We already knew China was slowing. Growth in 2014 was 7.4 per cent – the slowest since 1990. And the IMF expects growth to dip to just 6 per cent in 2017. But there are signs things could be getting worse more quickly than even those forecasts. A survey of Chinese manufacturers last week pointed to the weakest level of activity in August since 2009. And earlier this month the Chinese authorities devalued their currency by 4 per cent in just two days. Many traders took that as a sign that the economic authorities in Beijing have got wind of something far worse- and sold their stocks in response.  
Beijing is grappling with the end of a massive credit cycle. It managed to pump up its domestic growth rate in the global financial crisis by ordering its banks to extend a huge amount of credit to property companies. It was one of the biggest explosions of borrowing ever in a single country in history.
But the authorities are afraid that creating even more debt could lead to a financial collapse, or even bigger economic distortions. They are slowing the pace of credit growth and investment and trying to shift the economy into new sources of growth such as consumer spending.
As they do this the growth rate is – inevitably slowing. The great danger is that without credit-fuelled investment the economy will slow to quickly and China will experience a “hard landing”.
The FTSE100 index of leading UK shares has taken a battering along with the rest of the world’s stock markets. But most UK forecasters expect the economy to keep growing at a reasonable pace this year. The CBI today forecast 2.6 per cent GDP growth.
The discrepancy lies in the fact that many of the companies listed on the FTSE100 are global multinationals, whose fortunes are linked to the world economy, not just the UK. The CBI and other forecaster think that trade won’t help the UK grow this year – export growth will be disappointing. But they also think that domestic household spending and business investment will take up the slack and keep the wheels turning.
The great fear as far as the world economic outlook is concerned is global deflation – falling prices – as a result of China’s slowdown. Deflation is very bad news for global GDP growth and, by extension, the stock price of global companies. Global growth expected by the International Monetary Fund expected to be its weakest since the
A slowdown in China will hit demand. But there is also a separate depressing factor, namely a glut of supply too. America shale oil producers have brought huge new supplies to the market. And Iran is promising to increase production after Tehran’s recent nuclear deal with the US.
The price of a barrel of oil hit just $45 yesterday for the first time in six years. This is helping to hammer the prices of oil companies around the world.
Greece has been the dog that did not bark. Its Syriza leadership capitulated to the demands of the country’s creditors and agreed to more fiscal austerity. This removed the possibility of a “Grexit” and mean investors in European markets could relax.
The Greek prime minister, Alexis Tsipras, did resign and call new elections last week. But very few traders are expecting the Athens government to fall and for a new European financial crisis to break out.
Many market participants are expecting one or more central banks to ride to the rescue in the near future to help restore confidence. This could take the form of action from the Chinese central bank to pump up growth by making it easier for Chinese banks to lend money to companies.
Alternatively the Federal Reserve may get cold feet and delay its first interest rise. It’s also possible that stocks could bounce back.
Many traders are on holiday in August meaning trading volumes are relatively thin. In these markets changes in sentiment tend to have a much bigger herding effect. It’s possible that when more traders return they may take more sanguine view of the prospects of companies that make up the global indices and prices may recover.