Right now, China’s stock market is crashing. In the past month, the Shanghai Composite Index (essentially its version of Australia’s All Ordinaries Index) has fallen by 30%.



The sell-off of stocks prompted the Chinese government to try to stem the tide. At the end of June it cut its official interest rates to 4.85%. This was the fourth such cut this year.

The interest rate is now 115 basis points below the 6.0% it was this time last year, yet the share market keeps falling.

On Wednesday the Chinese government got all bolshie and suspended trade in about half the stocks. A state-owned wealth fund began buying just under $20bn worth of shares with a view to hold them until the Shanghai index had risen 20%.

It is sweet to see a communist government, in 2015, try to hold back market forces.

It worked about as well as you would expect. On Wednesday the market opened down 8% on the previous day. It recovered a bit during the day before finishing down 5.9%.

Capitalism 1, communism 0.

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But while this all sounds pretty much like doom, it’s worth noting the Shanghai Composite Index remains 72% above where it was 12 months ago.

The reality is the Chinese stock market was in a massive bubble, fuelled by margin lending (where people borrow to buy shares) and investors seeking better returns as the Chinese property market faltered. Now it is bursting:

How big the burst will be is, as ever, up for debate. Some suggest a lower level may have been found. But the Hang Seng Index in Hong Kong, which is generally a good guide to how the Chinese market will go, lost 8.5% of its value on Wednesday. Now it is 1.2% below where it was a year ago. Clearly the Shanghai index has grown a tad out of whack with economic reality.

So should we be worried? Well, yeah.

In the normal course of events, a fall such as this would not be overly worrying. Clearly a correction was required; stock markets often see a fall after such a rapid rise as we saw this year in China.

Measures the Chinese government has introduced in the past week – allowing for greater margin lending, suspending stocks, stopping the release of new stock issues – smell like panic.

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You could argue that such was the size of these measures, they themselves helped fuel some of the selling on Wednesday. Panic begets panic.

It’s a panic that suggests the Chinese government is more than a bit concerned about the impact of any falls on the broader Chinese economy.

Some commentators have noticed the parallels between China now and the United States in the 1929 Wall Street crash, which also followed large margin lending.

Such talk gets pretty scary, given China accounts for over 30% of Australian exports:

The Chinese economy is not doing well, despite its government’s best efforts to boost growth through easing monetary policy. The latest industrial output figures show annual growth not far above where it was during the GFC:

The sense is that China’s ability to grow off the back of its cheap exports is diminished, given increases in labour and production costs. Thus now it aims to produce more of its growth from internal consumption.

It is becoming less likely that China will be able to reach its target of 7% annual GDP growth. The fall in the share market – while perhaps not having as huge an impact on people’s wealth as it would in other nations where more people own shares – will certainly not make for brave spending by Chinese households.

China remains a command economy, which gives it ballast against a Great Depression-like outcome. Its financial and economic system is able to essentially ignore economic realities to keep lending and spending.

But that can only happen for so long before reality kicks down the door. This week the share market has shown the limits of the government’s power, and that will not go unnoticed by Chinese consumers.

The Chinese housing market, although slightly better than it was six months ago, is unlikely to gain much strength from this. Declining Chinese consumption growth and a continuing weak housing market spell bad things for our exports.

The latest advice by the office of the chief economist in the Australian government’s Department of Industry noted that “China’s steel exports remain elevated against expectations but in the absence of a housing recovery, China’s steel production is likely to drop in the short term”.

Forget the housing recovery now, it would seem. And with steel production falls come a fall in iron ore prices – which have slumped below US$50 a tonne in the past week:

For the moment the price remains above that forecast in the May budget, but the wriggle room is getting small – and any further falls start to really hit the budget’s projected bottom line. Shrinking as well are the profit margins for mining companies. BHP has a break even price on iron ore of around US$50 a tonne and for Rio Tinto it is in the low US$40s.

One bright spot for us is this is also driving down the value of our dollar – on Wednesday it went below US75 cents for the first time in six years:

The RBA has been desperate for the dollar to fall to around US 70 cents and, given the likely further fall in iron ore prices, that must now be a real chance. Non-mining exporters will be cheering.

But with the falls in those prices also come falls in our national income and concerns that the dollars (both in profits and in tax revenue) from the export side of the mining boom may not be as bountiful as hoped.

As the apocryphal Chinese curse goes: “May you live in interesting times.” Thanks to China, the times are interesting for anyone trying to manage our economy.