China’s Self-Inflicted Wounds Can Harm the Rest of the World, Too

Twenty-nine minutes.

That’s how long it took for Chinese stocks to fall 7 percent Thursday, forcing an end to trading. It’s the second time so-called “circuit breakers,” meant to stem massive sell-offs, have kicked in this week. In just four days, Chinese equities have lost nearly 12 percent of their value, wiping out $45 billion in U.S. wealth.

Panic soon spread west to Europe; in Germany, the DAX fell 2.29 percent, while in England, the FTSE 100 fell 1.96 percent. It then jumped across the Atlantic, where the S&P 500 fell 2.37 percent and the Nasdaq was down 3.03 percent. The Dow Jones industrial average closed down 392.41 points, or 2.32 percent. It’s the fourth straight day of losses, and the index’s worst start to a new year in history.

All of these red numbers are likely to strike fear into market watchers and policymakers around the world. But according to experts, much of the pain China is feeling right now is self-inflicted. Officials in Beijing are struggling to figure out how to make economic policy that will allow China to further integrate with the rest of the world, something both the International Monetary Fund and the United States want, while maintaining a veneer of economic invincibility in the face of slowing growth. Their efforts to do so are making everything worse.

“Any sense that [Chinese regulators] are the masters of the universe is gone,” David Dollar, a senior fellow at the John L. Thornton China Center at the Brookings Institution, told Foreign Policy Thursday. “The way they’ve handled the stock market has undermined confidence. The way they’re handling exit from a fixed rate [on their currency] isn’t going well. They’re not communicating very well.”

That, in turn, leads to the steep losses the world has experienced this week. If the stewards of the world’s second-largest economy, one which thrived while other countries stumbled during the Great Recession, can no longer be relied upon to properly steer China’s ship, investor confidence in the nation’s future will be undermined. And that raises the possibility of spillover into both China’s neighborhood and the United States.

“There’s a big disconnect between markets and the way Chinese regulators think about the markets. Neither trust each other anymore,” Scott Kennedy, a China expert at the Center for Strategic and International Studies, told FP. “Markets used to trust China would manage [its] markets correctly. Now they’re not sure if [Chinese officials] can manage or if they’re committed to economic reforms.”

Top U.S. officials are open about their fears that China’s economic chaos could spill over into the United States. On CNBC Wednesday, Federal Reserve Vice Chairman Stanley Fischer said, “If all China’s neighbors and large other parts of the world are negatively affected to a considerable extent by China, then that would be an impact [on the Fed’s decision-making].”

“The rest of the world matters for us,” he added. Fed chief Janet Yellen has also cited concerns about China’s slowdown when keeping interest rates near zero for most of last year; she finally lifted the cost of borrowing in December.

Chinese policymakers, for their part, have seemed confused and paralyzed about how to respond to the growing chaos in the country’s stock markets. On Thursday, regulators suspended the circuit breakers — a policy implemented on Jan. 4. That means there will be little they can do if the market tanks again Friday. But removing automatic trading halts also allows investors the opportunity to buy up stocks on the cheap.

Chinese officials have also waffled on their decision to ban stock sales by large shareholders. This policy was put in place last July after the Shanghai composite index lost nearly 40 percent of its value. The restriction was set to be lifted this week, but the China Securities Regulatory Commission has now extended it for three months.

Officials in Beijing also appear uncertain over how much they want international market forces to determine the value of the renminbi, the country’s currency. They devalued the currency by 2 percent last August but only allowed the renminbi to float, or let market forces determine its value, for three days after the Chinese currency plunge caused a stock sell-off around the world.

Since then, the renminbi has been steadily allowed to lose value, which, in theory, could spur economic growth because it makes Chinese exports cheaper. But on Thursday, when the People’s Bank of China allowed its currency to sink to the lowest value compared to the U.S. dollar in almost six years, traders interpreted the low valuation as a sign of broader weakness in China’s economy. Cue the selling bonanza.

Kennedy said fear of this perceived weakness is what drives Chinese officials to draft a piecemeal approach to their equity and currency markets. This is doing nothing to bolster confidence abroad, he added.

“They are obsessed with the idea of maintaining a strong currency and not wanting to be vulnerable to global market forces,” he said. “There are now real questions about their liberalization. Are they only happy with markets when they go up?”

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