There's been plenty of hot press these last few weeks over the debacle in China’s stock markets. After a huge run up in the last year, of 125%, the market is in sharp decline, having lost half of that gain in just a few days. Analogies with the crash of ’29 rebound around the Internet, but the reality is far different and far more complicated.
China is NOT a capitalist country. Most stock floats comprise only a small portion of a corporation's issued stock. Moreover, stock ownership by state entities, either directly or through proxies, is a major factor. Then add to that the Chinese government's willingness to micro-control the markets if necessary and it becomes clear that a loss of $3 trillion in “wealth” may not destroy the economy.
In fact, the stock exchanges are in the main licensed gaming houses, with this bubble occurring as small unsophisticated investors jumped into sentiment buying on a rising market and leveraged margin heavily. External investors own so little of China's stock (1.5%) that their exposure is low. So why get excited?
First, this mess (and it is a mess) is a slap in the face for the top level of government. Last year, they promised a more open market, and instead have introduced extensive and even draconian controls to stop the collapse.
Second, there will be a crisis of confidence that will ripple into internal and international trade. Lending policy will be under scrutiny to limit margin trading and attempts to hide trading losses.
More importantly, China has managed to get into a perfect storm in a number of areas simultaneously. International relationships are very strained over the South China Sea issue, where all of China's maritime neighbors are united in holding off a bullying position. Arresting South African nationals for opaque reasons while their Secretary of State is on an official visit smacks of diplomatic clumsiness of the first order.
If this were not enough, China is sitting on a ticking real estate time bomb, where leveraging mortgages has been taken to a new level. The financial exposure here makes the stock market issue pale in comparison, though it doesn't currently seem likely that the stock market issue will trigger a real-estate collapse.
All of this may be savable by the government. After all, the rules in China aren't the same as any other country. The State and the Party rule, not the democratic free market. But these problems highlight the imbalances in doing business with the Middle Kingdom.
It is virtually impossible for a foreign entity to own a Chinese company. Local control is required and often that means a controlling interest by one of those state-controlled entities. With China's demonstrated ability to place controls on corporations at will, as seen in the last few days, foreign companies must be asking if their investments are viable.
The balance of trade is a major issue. It's clear that China operates more as a single huge corporation than as a free market. Imports are minute in comparison to exports. The US exports just $120M annually to China and most of those intermodal containers from China end up in US scrapyards.
The trade issue points to another of China's storms. Labor costs have risen sharply over the last five years, and the economics of “Made in China” are being called into question by even major Chinese companies. Taiwanese firm Foxconn, the employer in China, is discussing a move of 1.2 million jobs to India over the next few years. This might be a political ploy to leverage government concessions or to appease Apple, but it highlights the cost issues. The social impact of this and other companies leaving would be substantial
Meanwhile, the U.S. government has to decide if it will intervene in a rumored purchase of the sole US DRAM manufacturer, Micron, by a Chinese state-owned conglomerate. This may be the strategic straw that fractures the camel's back. Clearly, the open market dream of a “New Open China” is mostly fictional, while the bargain is one-sided and with a nation beginning to rattle the saber a bit.
Does this mean more on-shoring back to the U.S. and EU? That seems like a possible strategy. Not only does it create a more agile US market, it brings jobs back to cities, potentially returning the US economy to a level last seen before GW Bush. The economics for on-shoring are much better than in years, and the turmoil in China creates a time to review and decide.
China's top leaders appear to be a pretty competent bunch and they may well succeed where others have failed, but these are definitely “interesting times”!