Plunging Chinese stocks have been sending worsening ripples across global markets all year, prompting fears of spillovers and recessions.
China’s Shanghai Composite Index lost 8 percent last week alone and is down more than 20 percent since a recent high in December, putting it in bear-market territory. That slide and the accompanying concerns about the world’s largest economy have sent stocks in the US, Europe and elsewhere into a tailspin. The Dow Jones Industrial Average and Standard & Poor’s 500 are both down 9 percent for the year.
This isn’t the first time in recent memory that tumbling Chinese stocks cascaded across the globe following a sharp rise. The same thing happened last May, in part because China is in the midst of a difficult transition from an economy emphasizing capital investment, exports and savings to one based on innovation, services and greater consumption.
A byproduct of this transition into a more mature economy is slower growth. Typically, as a nation progresses from poor to middle income – and from basic needs and manufacturing toward a service economy that includes more creativity and intellectual assets – growth rates naturally slow down for reasons economists do not fully fathom.
But what’s really behind all this angst, the booms and the busts? And are investors and traders right to be increasingly concerned about a global recession?
A longer-term view suggests the fears are misplaced: the world economy will actually benefit from a successful transition in China, despite a few bumps along the way.
And as for the cause, it helps to examine Chinese culture and history. A heady brew of frugality, wild risk-taking and amateurism has created huge bubbles – ones that were bound to deflate.
These are some of the lessons I’ve learned from following China’s economy for two decades, witnessing firsthand the fascinating transformation of places like Beijing from cities of bicycles with few cars and clear air to ones known for massive traffic jams and ubiquitous face masks.
China stocks: a brief history
First let’s take a closer look at the Chinese stock market’s behavior in recent years.
Despite the volatility, Chinese stocks have yielded among the best returns in the world. The graph below shows the change in the Shanghai Composite Index since its launch in 1991. Even with the wild swings last May and over the past month, it has returned a compounded average growth rate of 13.1% since it was created, double the rate of return for the Dow in the US and the FTSE 100 in Europe over the same 25-year period.
This kind of performance should be the envy of the world and not cause for fears and sell-offs elsewhere.
So why the angst and hand-wringing? Because Chinese markets also exhibit those distressingly wild swings, in amazingly short time periods. Consider the index’s 259 percent jump from 1,659 on August 6, 2006, to 5,955 on October 1, 2007, and the subsequent 69 percent plunge to 1,821 on December 1, 2008.
More recently, the index was 2,117 on August 1, 2014, but was madly propelled upward to 4,612 by May 1, 2015, followed by a crash to 2,950 on January 13.
Here’s where an understanding of Chinese culture and history comes in.
A tradition of frugality and savings
He who will not economize will have to agonize.
I have … precious things which I hold fast and prize. The first is gentleness; the second is frugality.
Until a generation ago, most Chinese were poor. Their sages like Confucius (the first quote above) or Lao Tze (the second) wrote proverbs that made a virtue out of sheer necessity.
Mainland Chinese culture today is still in a transition in which sudden affluence has not yet erased the frugal habits of the past. Hundreds of millions in China grew up mainly on noodles or rice, with at best tiny portions (under two ounces) of meat served no more than three times a week to accompany the starches. While today they eat better and partake more of flesh, the parsimony of the past lingers in the unusually high savings rate in China.
The average American household – depending on the state of the U.S. economy – saves between -2 percent and 4 percent of its income. By contrast, the typical Chinese household saves about 30 percent of its disposable income. As a result, China has by far the world’s highest gross saving rate as a share of GDP, according to the World Bank.
This is something the Chinese government is trying to change by encouraging consumption. But altering this millennia-old habit will take a long time. Meanwhile, the huge savings surplus has to go somewhere.
What choices does a family have to invest its savings? Only so much can go into gold or other valuables. The bank, a relatively new institution in China, offers meager yields that turn negative when factoring in inflation (meaning when you withdraw your money a month or year down the road, you’ll have less spending power than when you deposited it). Real estate is perceived as an overinflated bubble destined to pop, and government capital controls prevent investment abroad.
Frugality and risk-taking: odd bedfellows
Pearls don’t lie on the seashore. If you want one, you must dive for it.
― Chinese proverb
It seems like a paradox that Chinese traditions emphasize frugality, while at the same time its culture lauds risk-taking.
Studies by business professors Elke Weber and Christopher Hsee concluded that when it comes to social interactions, Chinese are indeed conformist and risk-averse. However, in financial transactions, Chinese are significantly bolder than investors in many western nations, something also corroborated in Chinese proverbs that appear to provide greater risk-taking advice than American proverbs.
Gambling also has a long history in China. Desmond Lam, in his “A Brief Chinese History of Gambling,” relates how games of chance began as early as the Shang Dynasty (1700–1027 BC). Gambling became an obsession amongst high officials as well as common folk. Gambling parlors proliferated in the Qing Dynasty, and continue to this day.
The widespread willingness to gamble is also illustrated in a survey (conducted early last year by State Street Corporation) that showed that as many as 81 percent of Chinese investors traded at least once a month, which is by far the highest rate in the world.
Mania over a quick buck
And that brings us back to the recent volatility.
In April 2015, hairdressers in Shanghai or Shenzhen were telling their customers how they had doubled their investment in just two months between February and May 2015. The S&P 500, by contrast, barely budged.
The mania for a “quick buck” affected all levels of society, down to workers with relatively few savings. It was a wild run-up similar to the tripling of share prices from October 2006 to October 2007, followed by the almost predictable collapse to the original levels by December 2008.
To the nouveau riche in emerging nations, modern finance is a brave new world, leading to speculative excess untempered by losses. The crashes in 2007 and 2015 did not deter new hopefuls from entering this game in China.
That’s at least in part because there is a lot of pent-up money in China, chasing very few options. This, plus the fact that most Chinese investors are novices and are willing to take more risks than Western investors, explains the wild swings in the Chinese markets.
Moreover, the gyrations in the Chinese stock markets have little to do with the actual fundamentals of the economy, despite some recent headlines. That’s the conclusion of a recent study by scholars at the Wharton School and Shanghai Jiaotong University, calling the typical correlation between stock returns and future GDP growth “statistically insignificant.”
No need to panic
So will the behavior of less than one percent of the Chinese population – those who invest in shares – drag China and the rest of the world into a recession in 2016?
The likelihood is low. Too much is being read into the slowdown in inflation-adjusted GDP growth, which is forecast by the IMF at a little over 6 percent this year – still a remarkable performance and among the highest in the world. And as noted above, volatility in Chinese stocks isn’t necessarily a sign of anything in the real economy.
Regulators, in fact, may deserve some of the blame by acting amateurisly with new “circuit breakers” that halt trading if the main index falls by more than 7 percent. Doing so may actually be making matters worse by broadcasting a “panic” signal to investors.
True, the Chinese economy is undergoing a tricky transition involving the fundamental restructuring of how it grows. The world will be better for it, thus to investors worldwide: don’t panic.