China Jitters

World Sharemarkets Are Sneezing. What Does That Tell Us About the World Economy?

Before discussing the state of the world economy – especially what is going on in China – it is useful to say something about the importance of the sharemarket (Americans call it ‘stock market’). It is far more important in pop-economics than serious economics.

This is because there is a new share price almost every second of a working day, easily reported especially if journalists have nothing else to do. There was almost a news blackout on it following David Bowie’s death because the media thought they had something of greater public interest. But on a dull news day, journalists report minuscule changes in the sharemarket with panting breaths. As I write it is in the headlines again.

Additionally, those who make their money from share deals have an interest in presenting the sharemarket as more important than it is. (Everyone does that; I once met a designer who thought the cover was the most important aspect of a book.) So those whose incomes depend upon share transactions are happy to feed the breathless media with material to eke out the story. A similar situation applied to the Auckland housing market with the media uncritically reporting real-estate hype contributing to the speculative boom.

This is not to say the sharemarket has no economic significance. Every market has some. The sharemarket can be a means for raising capital for firms, so it is a means of saving. However, especially for the greedy and uninformed, it can be a means of losing savings – as investors in Dick Smith are ruefully realising.

(One could argue that one of the market’s functions is to transfer savings from the poor to the rich – as Keynes said it is a kind of casino. I’ll mention this gambling again, but it is not a reason against investing in shares. Rather that the investor should be aware they are taking on higher risk and may get a higher return – or they may not.)

Perceptions in sharemarkets also affect business and consumer confidence. High share prices may give the impression that shareholders have more wealth leading to greater spending. When the prices collapse they think they are poorer and cut back.

So when you are told that the share-price index has risen or fallen by, say, three percent, it means just that. The economy – and certainly not wellbeing – is not three percent better or worse that day, it has hardly changed.

So the announcement that the prices in the Shanghai sharemarket are falling – as they have been recently – does not tell us much about what is going on in the Chinese economy (more’s the pity, as I shall explain). Moreover, since the Chinese sharemarket is smaller relative to the economy than rich country ones, changes in it do not have as much direct impact as a similar percentage fall in, say, the US.

A further complication is that it would seem that the Chinese government is involved in its sharemarket far more than is normal. It is said that it has instructed state-owned firms to purchase shares; even Muldoon did not intervene to this extent.

The Chinese economy is an even greater mystery than most economies. Its data is unreliable, some institutional arrangements are unclear and the policy framework is less transparent than usual (probably because there are heated internal debates). The economy is thought to be slowing down from a secular growth rate of, say, 15 p.a. to 5 p.a. I cant think of any economy which has experienced this sort of deceleration, so we cant be sure what will happen except that the ride will be bumpy.

Because we know so little about what is going on, it is difficult to make prognostications. A worry must be that some of the investors (or should we say gamblers?) in the Shanghai market have borrowed to fund their sprees. That works well when the market booms, but when it crashes some of those who borrowed may not be able to cover their debts.* That can generate a severe disruption because an economic actor cannot function with negative equity in their balance sheet – as Dick Smith demonstrates – and the unwindings to cover the negativities can be very messy – as Dick Smith will show.

Even though there is little in the Chinese economy which is transparent we can take the Shanghai sharemarket as another indicator, among many, that the economy is weakening.

Of course, that one of the world’s biggest economies is faltering – we think – has implications for the rest of the world economy. The uncertainty there is being transmitted to the major sharemarkets of the world, impacting on business (and consumer) confidence.

So we cannot rule out that a general weakening of the world economy which will, of course, impact on the New Zealand economy. We do not know by how much. Our economy is also weakening from lower export prices, the winding back of the Christchurch rebuild and the faltering of the Auckland housing bubble.

My guess is the current forecasts are on the optimistic side of what will be the actual outcome. By the middle of the year the economy may not look as robust as it been. It is too soon to tell whether it will be recovering by the end, as we go into election year.


* The recently released film The Big Short makes a heroic attempt to describe what happened in the gambling boom and bust of the American housing market which precipitated the Global Financial Crisis.