China’s stock market isn’t the problem

Dark days in Dongguan.
Dark days in Dongguan.
Image: Reuters
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China’s stock market is a scary place right now. But it isn’t the real problem.

Sure, shares are down nearly 12% in the first few days of 2016, as measured by the Shanghai Composite. They tumbled by more than 7% today alone, before a circuit breaker halted trading.

It was the second time trading was halted this week, an indication that the effort to reduce market volatility is doing little to actually quell waves of stock selling. (Another sign that it wasn’t working: the circuit breaker is being scrapped.)

As jarring as it is, the sharp decline of the stock market is just a symptom of a bigger problem for the Chinese economy. For decades, money from around the world has poured into China—as well as other emerging markets—to take part in one of the great booms in economic history. And now, that flood of cash is reversing course.

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When the numbers are tallied, last year will likely have seen the first net outflow of capital from emerging markets in 27 years, according to the Institute of International Finance, a trade group representing international bankers. The group expects more than $500 billion worth of cash previously invested in things like Chinese factories, Brazilian government bonds, and Nigerian stocks to cascade out of such markets this year.

These are just forecasts, but there’s plenty of other evidence that’s consistent with this story. For instance, over the last few decades, the flood of foreign currency into China has resulted in a giant pile of currency reserves. (China has more than $4 trillion in reserves.)

But lately, that pile of reserves has been shrinking fast. Just today China announced that it had burned through more than $100 billion in reserves in December, as it tried to keep the currency propped up in the face of large-scale selling by investors.

Like its effort to quell the stock market rout, China’s effort to keep its currency from collapsing is part of the central government’s commitment to manage a slowdown of the world’s second-largest economy and keep it from turning into a panicky recession full of unforeseen risks.

Alternately, China could let the currency weaken further, saving some of its reserves. That’s what China did today in allowing the biggest decline in the yuan in five months. But allowing the currency to decline could also make the market situation worse, by driving nervous investors to sell Chinese assets even faster in order to avoid further currency depreciation.

In short, fixing this won’t be easy.

But given the globe’s increasing reliance on China for growth, we should all wish them luck.