(Editor's Comment: Welcome to the first guest post on WCM. Guest author Evan Yang is a close personal friend of the blog and current expat living in Shanghai as the Finance Manager of Business Operations at ConAgra Foods China.)
So What’s Going on with the Chinese Economy?
There has been quite a bit of volatility in the US stock markets recently in a large part driven by news from China. What I want to do is to provide some context around key news coming out of China markets.
China’s GDP (Growth Domestic Product) growth is forecasted to come in at slightly less than 7% growth this year. This is the slowest percentage growth in the last 25 years for China.
Simply put GDP is a measure of countries economic activity and comprises of:
- Consumption - How much is being utilized in terms of goods and services
- Fixed Capital Formation - How much investment in infrastructure currently being made within the country
- Net Exports - The difference between exports vs. imports
Many feel that the GDP growth % in China is alarming due to the Chinese economy slowing down in terms of the historical growth rate. The general consensus among economists is that the Chinese GDP growth rate will continue to slow down to ~4% to ~6% range by 2020.
China devalues the national currency (RMB/CNY) to match closer with market rates. Currently trading at ~6.4 to 1 US dollar vs. ~6.2 to 1 US dollar about 2 months ago.
There are a couple of potential reasons to the recent currency devaluation.
One is that it helps to boost GDP growth by boosting exports. With a cheaper currency it allows for exported goods to be cheaper and more imported goods to be more expensive. For example if you are an importer of Chinese goods into the US market, and you used to pay $1000 for 6,200 worth of RMB goods. Now with with currency devaluation you would only need to pay $968.75 for 6,200 worth of RMB goods. So by effectively lowering the currency rate, exports are more attractive and by association GDP growth.
Another reason is that loosening the reins on the China currency and allowing it to get closer to market rates can better position to get the currency added to the IMF basket of world reserve currencies. The current world reserve currencies are the USD, Euro, British Pound, Japanese Yen, Swiss Franc, and Canadian Dollar. As the WSJ states
“Getting the yuan labeled a reserve currency would allow Beijing to flex its muscle more in the global economy, a key step in boosting its global role, as it is challenging U.S. political and economic dominance in world affairs. It would likely accelerate demand for the Chinese currency, especially by central banks.”
Stock Market SHCOMP has dropped (38%) since high in June.
The key risk here is that many investors got into the stock market as part of rally to the the high. With investors tying up funds in the stock market, a drop of ~40% causes quite an impact on discretionary income. This in turn effects the consumption piece of GDP.
Putting this news together has made markets jittery, and created quite a bit volatility in the stock market. Investors generally invest based on the intrinsic value of a company or the future earnings potential discounted back to present value, and the recent news has created uncertainty in terms of the future earnings potential. One thing to keep in mind is that although China’s GDP growth at 7% is the lowest it’s been in recent years, on a nominal basis the economy is expected added about $700 Billion in value (the size of the total GDP of Turkey) in 2015. This is in comparison to the mid 1990’s when GDP was growing double digit %’s, and adding $150 Billion every year
How Does This Affect Me?
One question may be - this is good and all to learn about China but how does this effect the US? The main reason here is that global economies are much more interconnected than before with trade occurring all over the world. When one economy struggles, it can effect consumption (products from abroad), net investment (consumption of materials), and also net exports and imports of other economies.
(Editor's Comments: Most of WCM readers' personal finances will be unaffected by minor economic volatility in China. However, the risk here is exactly as our guest author has explained - the interconnection between nations in today's global economy means that while you can be cushioned from a market correction in China, it's nearly impossible to be insulated from a prolonged Chinese economic slump - or even the hint of it.)