A Surprise From Shanghai
A one-way street used to link the U.S. economy and the world's emerging markets: American consumers fueled demand for goods and commodities from abroad. But it was clear last week that the traffic now runs both ways, and what happens in China can spur or curb U.S. growth.
This is why, after Chinese equities fell nearly 9 percent in a single day last week, U.S. investors rushed to dump their domestic shares in a sell-off the likes of which hadn't been seen since after the 9/11 terrorist attacks in 2001.
Thanks to its sheer size and manufacturing base, China is proving to be the engine that is powering the global economic expansion. China accounts for roughly 30 percent of the world's economic growth, says Alec Young, international equity strategist for Standard & Poor's Equity Research.
If the Chinese stock market bubble bursts, will the global economy tank? Not necessarily, because there's a distinction between China's stock market and its economy.
The system. In most countries, equity prices try to gauge future economic conditions. But Edmund Harriss, portfolio manager of the Guinness Atkinson China & Hong Kong Fund, notes that because China's financial system is so restrictive, its stock market doesn't perform that way.
In fact, while Chinese stocks were getting hammered last week, Standard & Poor's reiterated its forecast that China's economy will grow by nearly 10 percent this year.
So what is spooking Chinese investors? In short, government threats to rein in the stock market through more regulation.
Reforms are probably needed to cool down the irrational exuberance for so-called A shares, the stocks of Chinese companies based on the mainland that are available mainly to local investors. Last year, the A-share market soared more than 100 percent.
Chinese investors, Harriss notes, have "no general freedom to move money in and out of the yuan or in and out of the country." So, their only alternative to investing in local stocks is sticking their money in bank deposits, insurance contracts, or government bonds. But those investments are paying out only about 2.5 percent a year.
With the spectacular recent returns of Chinese equities, it's easy to see why the Chinese have driven the markets up so high—and why they panic when they fear their opportunities to invest may be curtailed.
This story appears in the March 12, 2007 print edition of U.S. News & World Report.
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