Turmoil in China


Not Just a Bubble

Sometimes, we seem to be surprised and alarmed that financial markets in China are troubled, as if we expected that capitalism there was going to be different. Sometimes we are condescending about it, as if we knew all long it was going to be exactly the same.

It’s not surprising that the Chinese themselves were caught off guard. They have not had our lengthy experience with capitalist boom and bust cycles. Moreover, their pride in the remarkable progress their economy has made in just over 35 years may have blinded them to the risks. They might well have believed it could go on forever.

The Wall Street Journal put it rather smugly: “the Chinese Communist Party’s leaders have now been forced to confront a creature of their own making as it rises up and goes its own way, immune to their attempts to bend it to their will.”

But as The Economist pointed out, there has been an extraordinary amount of state intervention: “a spectacle of ever-more drastic actions to save the market. Regulators capped short selling. Pension funds pledged to buy more stocks. The government suspended initial public offerings, limiting the supply of shares to drive up the prices of those already listed. Brokers created a fund to buy shares, backed by central-bank cash.” And so on.

The puzzle is why so much effort and alarm? China’s economy’s over-all growth is stable and asset markets are performing well. Turmoil in financial markets is not the same thing as economic collapse.

As The Atlantic observed: “the Chinese economy is more insulated from stock market fluctuations than those in developed countries like the United States. The stock market just isn’t a huge driver of economic activity in China: According to The Economist, less than 15 percent of overall household assets are invested in it.”

We, on the other hand, the poster child of Investor Capitalism, are almost fully invested with our mutual funds, mortgages, retirement accounts, hedge funds, college funds, etc. Moreover, our businesses are constantly resorting to financial markets to fund a steady stream of buy-outs, mergers, acquisitions, and restructurings.

So why the alarm in China?

To be sure, many Chinese were lulled into the belief, a common feature of financial bubbles, that investments can only go up. And some investors in the west, mesmerized by China’s economic miracle, rising so quickly to become the world’s second largest economy, might have been convinced that China is an exception – as, in the past, digital technology once seemed an exception, and sophisticated financial instruments seemed to make subprime mortgages safe.

But what China is experiencing is no different from the many episodes of turmoil in financial markets we have experienced repeatedly over the years, most recently, of course, in 2008. That is the conviction of Kenneth Rogoff of Harvard, who has written extensively about the long history of market meltdowns and our susceptibility to the erroneous conviction that This Time Is Different, as he and Carmen Reinhart put it in their prize-winning history.

What is different this time, though, is that China is troubled by extensive corruption in its ruling class, severe environmental pollution and dramatic failures to monitor safety, as witnessed by the devastating explosions in the port of Tianjin.

As Rogoff put it recently in The Times, “Financial meltdown leads to a social meltdown, which leads to a political meltdown. That’s the real fear.”