The times they are a-changin’ in China

If there is one rule in the stock market, it’s that whatever comes up, must eventually come down. Just like Newton’s law of gravity, the stock market is susceptible to natural forces. It was greed which caused investors to over-value Chinese stocks to begin with, and it is fear which is currently gripping the trading community, causing everyone from individuals to large financial firms to sell-off their shares.
So, will the Chinese market ever rise again? What are the crucial factors investors should be watching out for, and what effect will this have on global markets? The good news, if there is any, is that a change is going to come. As Bob Dylan sang: “the times they are a-changing.”
At this particular moment in time, China is a command economy. Unlike Europe and the United States, the Chinese government doesn’t trust the free market system. In communist countries, including North Korea, Cuba, and the former Soviet Union, the quantity of any goods produced and the price of those goods, are determined by the government.
The command economy system has worked for China up until now, but it is clear that a change is necessary for China to continue progressing into the future. China is interested in having its currency, the Renminbi, included in the IMF’s basket of reserve currencies, and this dream could bring about major reforms in China’s economy.
The second major change occurring in China currently is a crackdown on China’s shadow banking system. Unlike most developed nations, where lending is done by the big banks, in China there is a wide network of non-regulated lenders. Shadow banking has allowed riskier borrowers to receive credit by paying higher interest rates, and many analysts are now asking whether China’s over-valued stock market was caused by the inability to tame these risky lenders.
Michael Taylor, chief credit officer for Asia-Pacific at Moody’s, said in early 2015: “Although shadow banking has continued to grow, it has done so more slowly in recent quarters as regulatory measures to rein in the sector’s growth appear to be having an effect.”
Should the Chinese market continue to fall, investors must be on the lookout for the effect it could have on Europe. Europe is China’s largest trading partner, amounting to EUR 1 bln per day. European companies like Phillips, and BMW, have already expressed their anxieties that a weaker China could hurt their businesses. On that note, hopefully Chinese stocks will correct themselves soon. The Chinese economy isn’t the only thing at stake here.