Is China Really Crashing?

By Alvaro Vargas Llosa
The Beacon
Sep. 17, 2015

We seem to be panicking about China's economy. Let's pause and look at some of the facts.

First, consider the short-term concerns that sent shock waves across the world. Unlike the United States, where very developed capital markets are connected to the economy at large, in China the linkage is less strong. Even so, what has really happened to the stock market over there? The Shanghai Composite Index has dropped from 5,166 in June of this year to 3,005 as I write this--about 40 percent. But the index was at 2,059 in July of 2014, when the crazy bull market started, which means it is still more than 50 percent above where it was a bit more than a year ago! Many retail investors who knew little about investing were encouraged to put their money in stocks and use considerable leverage in the process, which caused the stock market to overheat. Things are gradually steadying.

Another short-term concern has been the devaluation of the Chinese currency. China allowed the renminbi to drop from 6.2 to 6.4 against the U.S. dollar. But today it is at 6.36, altogether a very small devaluation if we compare this with the average exchange rate in the first few months of 2015. On the other hand, the devaluation of the renminbi against other currencies such as the euro entails a simple correction: because of the strengthening of the dollar, the renminbi, which to a large extent had been shadowing the greenback, had risen against other currencies--so China let the value drop. But it is still stronger against the euro than it was a year ago.

Don't get me wrong. China needs to let its currency float rather than manipulate it politically like every other country. But the nation has taken a step in the right direction in the sense that it has started to move towards greater liberalization of the exchange rate, if only because officials want the renminbi to be accepted by the International Monetary Fund as part of its basket of official currencies.

Finally, look at the long-term issue. No economy can grow forever at 14 percent annually as China was doing before the international crisis hit. Also, that growth rate was based on levels of investment that could not be sustained indefinitely and was driven overwhelmingly by exports. Now China is going through an adjustment that will see its service sector take a much greater share of overall economic activity and consumers at home play a bigger role. This shift is gradual and, yes, somewhat disruptive. It is also more likely that we will see China growing at 6 or 7 percent for some years, allowing for inevitable hiccups.

Sure, this slowdown will mean commodity-dependent countries that were used to China gobbling everything they had to offer will need to adapt to a new normal in terms of a smaller Chinese demand. But eventually this adjustment will happen, and the current disconnect between supply and demand that is keeping commodity prices very low will come to an end. China's economy is now 16.32 percent of world GDP, and its share of world trade has tripled in fourteen years. If it keeps growing at 7 percent on average, it will catch up with the United States in 2021.

There are many things wrong with China, starting with its tyrannical political system, its human rights record, its interventionist economic system, and its credit and monetary excesses. But, despite all this, China's economy, one based on strong savings, entrepreneurship and factor mobility, is not crashing. It is still a powerhouse.













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