Market crashes after China fears

(Flickr / Baer Tierkel)

(Flickr / Baer Tierkel)

Markets around the world took a dizzying plunge Monday, with the Dow Jones Industrial Average falling more than 1000 points (about 6 percent) at the US market open. Last week was the worst in years for the major US market indexes, and they all experienced large slides Monday.

To add to the mayhem, oil prices continued to fall, hitting new six-year lows. Starbucks CEO Howard Schultz even asked baristas to be “sensitive to the pressures” customers may be feeling today as a result of the market crash.

So what happened? The most relevant answer is China. Much of the market selloff was related to fears about China’s slowing economic growth. The Shanghai Composite Index closed 8.5 percent lower, its worst one-day percentage hit since 2007, and that prompted a similar reaction from other markets.

China had historically been growing at around 10 percent per year, leading to what the Wall Street Journal called “one of the broadest, most rapid economic ascents in history.”

But signs have been emerging for some time that this growth is unsustainable. Many experts argued that China’s flourishing economy was primarily fueled by cheap debt and a market dominated by exports, and recently China’s growth rate has fallen to 7 percent.

Earlier this year, the Wall Street Journal reported on this slowdown in Chinese growth, and Ruchir Sharma of Morgan Stanley Investment Management warned that a Chinese financial crisis could be worse than Greece.

In his 2009 book, The Next 100 Years, George Friedman of Stratfor warned about the impending danger of China’s economy. Referencing unnervingly high rates of bad debt, Friedman argued that the existing Chinese political system incentivized giving out loans “for a host of reasons, none of them having much to do with the merits of business.”

As a result, many of these loans went bad, but these underlying debts were masked by high growth rates from cheap exports. But these growth rates wouldn’t last forever, predicted Friedman in 2009. “There are structural limits to growth, and China is reaching them.” Today, it seems, China has.

Max Fisher of Vox said in July that China’s authoritarianism was a key factor in leading it to this point. “The very nature of China’s authoritarian model, by basing its power on a sprawling governing elite that is heavily invested in the status quo, might now make it impossible for officials to do the things they need to do to keep the system afloat.”

There is some good news. Though this was one of the biggest ever points drops for the Dow, it still does not rank among the top 10 as far as percentage drops. Additionally, the markets did recover some of the losses throughout the day Monday, but still closed lower than they opened (except for the NASDAQ, which has proved more resilient than both the S&P 500 and the Dow).

China is also not the only factor in yesterday’s financial turmoil. Considerable uncertainty surrounds a looming Federal Reserve decision on whether to raise interest rates, and the economy is struggling through the implications of falling oil demand coupled with unexpectedly high supply.

Yet we should recognize that the stock market is an indicator of world economic trends and exercise caution in the months going forward. The situation in China is far from over.

Published on Opportunity Lives