According to the theory of the butterfly effect, if a butterfly flaps its wings in Beijing in March, then by August hurricane patterns in the Atlantic will turn out to be completely different. There is more than a flap of a butterfly wing going on these days in China. Stock market prices have plummeted and the Chinese Communist Party (CCP) has been reacting quickly. The CCP took the extreme measure devaluing the renminbi in August. The ripples of the Chinese stock market crash are resonating beyond the Chinese border.

It all started when the Shanghai Composite Index lost almost 30 percent of its value in June. The Chinese public panicked upon hearing news of the sudden drop of stock prices. Despite the slow economic growth compared to the past, the Chinese stock market grew rapidly over the first half of this year. As 70 percent of Chinese investors have been individual investors, they are terrified that their fortunes will disappear into thin air. The fact that ordinary Chinese people have invested borrowed money into the stock market has only aggravated the situation.

   
 

 

What Happened in China

 
The Chinese government was quick to take action. Government officials tried to slow down the stock market crash through employing various measures. Interest rates were cut by the People’s Bank of China (P BoC) in June. In July, stock exchanges were suspended and a state-owned investment fund, called Central Hujin started to buy up exchange traded funds. Also, the Initial Public Offerings (IPO) issuing was halted and state-owned enterprises were ordered not to sell their shares of stocks. Officers, directors, and listed company shareholders who owned over 5 percent of stakes were banned from selling stocks until the end of the year.
 
On August 10, the P BoC devalued China’s renminbi, or yuan, by almost 2 percent. This was an exceptional measure taken to boost the sluggish economy by fostering exports abroad. Put simply, devaluing one’s currency means that since goods produced on domestic soil become cheaper, exporters gain price advantages in the world market and exports are expected to increase.
 
Response Abroad
 
Many people criticized the extensive intervention by the Chinese government, arguing that the ruling party, CCP, was violating the freedom of investors and rules of the market economy. CCP’s decision to devaluate its own currency was like a bomb to stock markets abroad.
 
Despite the fall of stocks abroad, foreigners own just 1.5 percent of Chinese shares; thus, foreign investors will be relatively unaffected for the time being. However, if the stock market crash develops into a full-blown economic crisis, foreigners who did not even invest in China, will also be in trouble.   

The Cause of the Chinese Stock Market Crash
 
According to Professor Kim Ick-Soo (Business School), the current troubles in the stock market were triggered by several different factors. He argued, “The recent Chinese stock market crash can be considered as a form of market distortion. A distortion in the financial sector was caused by China’s recent opening up of the capital market, and the attempt by the government to privatize highly indebted stateowned enterprises.” Professor Kim further elaborated that the slump in the property market could also have propelled the crash. “Individuals’ assets need to be allocated into savings, stocks or property. Due to the tepid property market, people had few options but to invest their money into stocks.”
 
However, Professor Kim does not believe that the troubles in the Chinese stock market will unravel into a global financial crisis, as it is often feared in the media. He feels that the troubles in the stock market are a kind of transitional pain that China has to endure, moving closer to a genuine market economy. He added that the Chinese economy should be analyzed differently from the Western market economies. China’s economy is controlled by government officials. Thus, there are a lot of “noises” in the market. “China’s economy is not an efficient market, meaning that the volatility in the stock market has less impact on the Chinese real economy compared to other countries.”
 
Paul Krugman, a Nobel prize-winning op-ed columnist for The New York Times (NYT) agrees. “The stock market is a terrible guide to the economic future,” said Krugman in his August NYT column. Krugman further explained, “Every time one part of the world finally seems to get back on its feet, another part stumbles.” He argues that the 2008 Global Financial Crisis, Eurozone debt crisis, and the problems in the Chinese economy and other emerging markets are all related. He analyzed, “With America and Europe no longer attractive destinations, the global glut went looking for new bubbles to inflate.” In this case, it was China, Brazil, and other emerging economies that were inflated.
 
Nevertheless, Professor Kim is that, although China’s economic growth is slowed down, China will be able to survive. “China has never experienced this kind of volatility before. Everything had been carefully monitored and managed in the past. But over time, the market has gotten too complex and has become impossible for policy makers to know and control everything. However, Chinese policymakers are very competent and they have learned enormously from the current situation.” Also, China has a huge foreign exchange reserve, mounting to nearly 3.65 trillion dollars “From this we can conclude that China is on a bumpy road, not a cliff,” asserted Kim.
  

Contagion to Economies around the World
 
In today’s age of globalization, economies around the world are closely connected and interdependent on one another. The trembling of the Chinese stock market spilled over to emerging markets. “Commodity exporting nations, such as Brazil, Chile, Australia, Canada, and Indonesia, are especially vulnerable to the troubles in the Chinese economy,” explained Kim. China has been one of the biggest importers of natural resources from these nations. A slowdown is likely to lead to lower import demands, and major exporting countries will suffer. This is why the stock prices in the emerging markets plummeted alongside Chinese stock prices. “However, this is misinterpreting the signals and overreacting since the financial sector takes up only a small amount of China’s economy.”
 
Developed nations such as the United States (U.S.) will also be negatively influenced by the Chinese shock. Although the U.S. is rival nation to China, competitive growth is better for both economies to prosper. “The U.S. has been reviving its economy through quantitative easing, so its economy has been demonstrating positive signs these days, with better economic growth rates and employment rates,” said Kim. However, because the world economy has become unstable due to China, the U.S. Federal Reserve is uneasy about when to increase interest rates.
 
Europe is in a much more uncomfortable spot compared to the U.S. Approximately 16.5 percent of Chinese imports are produced in Europe. Roughly 23 percent of European exports are towards China. Thus, Europe has a higher trade dependency on China compared to the U.S. Japan will also be negatively impacted as Japan’s trade is increasingly becoming dependent on exports to China.
  

Future of the Chinese Economy
 
   
▲ Renminbi. Provided by chinaglobalimpact.com
Other than the trembling stock market, China is confronting many difficult challenges. China is suffering from severe unemployment especially among college graduates. By the year 2050, it is estimated that the number of people in the older generation will exceed the working population. There is also a housing bubble that prevents the younger generation from buying houses and starting a family. Life will especially be tough on young Chinese people as they need to pay more taxes to support the older generation and pay more to find adequate housing but cannot earn enough money due to high unemployment. Escalating conflicts between the majority Han people and the ethnic minorities are also an important issue that cannot be ignored.
 
Kenneth Rogoff, a professor of economics at Harvard University contended in his interview with the NYT, “Financial meltdown leads to a social meltdown, which leads to a political meltdown.” Some Western scholars even argue that China is heading to not only economic instability but also political turbulence. However, Professor Kim stresses that it takes more than economic troubles to make a country totally fall apart. “When there is a challenge, there is always a response. China is indeed facing grave challenges. However, these problems can be managed through correct policies.”
 
Kim agrees though, that bigger and greater struggles do lie ahead for China. “In the future, the point lies not only on economic growth, but also on redistribution of the accumulated wealth, securing employment, and increasing welfare and education.
  

Impact on Korea
 
   
▲ People devastated over the stock market crash. Provided by www.theguardian. com
Korea’s economy is exceptionally reliant on foreign exports with an extremely small domestic market. Approximately 82 percent of gross domestic product (GDP) is sustained by exports to other countries. China is Korea’s biggest trading partner, taking up 30 percent of Korea’s export abroad, including Hong Kong. Thus, Korea is obviously negatively influenced if the Chinese economy becomes unstable.
 
According to Professor Kim, another problem is that CHINESE ECONOMY 2 October 2015 45 Korea is facing a nut cracker situation. “In the past, goods produced in China were cheap but had low quality. However, nowadays, the quality of products made in China has improved significantly. Brands such as Haier and Xiaomi have gained technology and brand power.” In addition, due to the quantitative easing strategy employed by the Abe regime in Japan to foster growth, high quality Japanese products have become cheaper in the global market.
 
“Due to changes in the exchange rate, Korea can no longer maintain its position in the global market. Innovating technology, products, and brand power is the only way for the Korean economy to survive,” emphasized Kim. Kim also highlighted that Korea needs to diversify risks and become less reliant on exports to China. According to Kim, Korean companies have to escape from the Chinese shock and pioneer new markets in countries such as India, Vietnam and others.
 
Indeed, the recent turmoil in the China’s stock market has caught on to economies around the world. Media worldwide have been warning and scaring people that the current troubles in China are an omen for catastrophe. The risk of the turbulence developing into a full blown crisis has been exaggerated. Despite all the troubles, Chinese economy seems to be resilient for the time being.
   
▲ Professor Kim Isk-Soo. Photographed by Lee Ji Hoon.
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