The Chinese dream is turning into a nightmare

Investors and politicians have been whistling past the Chinese graveyard for far too long. The smarter observers were already warning that China's impressive growth record may have been to some extent fabricated. The repressive Chinese government could now be in trouble, and the world could be in for a bumpy ride

Shanghai
Shanghai: Not quite what it aspired to be
Michael_auslin
Michael Auslin
On 15 July 2015 09:43

China’s recent stock market meltdown isn’t the end of the Chinese miracle -- that already happened.

Instead, the 30 percent plunge in stock prices in just a month -- wiping out $3 trillion worth of wealth -- is just more evidence that China’s high-flying days are over.

The big question is whether the Communist government can contain the stock collapse, focus on needed economic reforms and, most of all, maintain the confidence of the Chinese people.

First, a bit of perspective. The stock market rocketed up 140 percent from July 2014 to July 2015. So a 30 percent drop is a big, but not unexpected, correction.

Moreover, the stock market only has about 15 percent of Chinese household assets. So while many investors are getting destroyed, most Chinese families shouldn’t feel the pain.

But that’s about all the good news.

The panic seems to be spreading, as worldwide commodity prices have fallen, thereby causing a drop in the value of the yuan.

Asian stock markets are also falling, and repeated Chinese government attempts to limit trading, reduce speculation and stabilize the market have failed. Now, Beijing is subsidizing the purchase of stocks and trying to prop up share prices, by giving money directly to the country’s largest securities firms to buy shares.

The big problem is that the stock market rise was fueled by new investors who had borrowed money to jump into the market. The amount of borrowed money in stocks increased to $322 billion this year, according to data reviewed by The Wall Street Journal.

These newbie investors are the ones getting wiped out, and are fleeing the market to cut their losses, thereby driving it down further. Despite the government's best efforts, Reuters reported on Wednesday that the Shanghai Composite Index lost a whacking 3.0 percent, to close at 3,805.70 points.

The broader lack of confidence in the government’s ability to control the rout means that longtime investors are also pulling out, worsening the cycle.

All this is part of a bigger problem: the end of China’s economic miracle.

For years, economists such as Derek Scissors have been warning that China’s economic data was suspect, that its debt problem was underreported and overlooked, that asset bubbles were building and that growth in China had essentially stopped.

Nobody selling the “China Dream” wanted to listen, though, and just like in Japan in the 1980s, investors and policymakers whistled past the graveyard while the danger signs mounted.

Now ignoring the cost of China’s structural problems is impossible -- but that doesn’t mean the problems will be solved. What could have been a measured and responsible approach for the Chinese themselves, not to mention foreign participants in China’s economy, is threatened by a tidal wave of panic.

The idea that market forces should be allowed to work their way through the system -- a reform goal supposedly trumpeted by President Xi Jinping -- seems to be all but dead, as the government scrambles to save its legitimacy.

Massive state intervention, to keep share prices up, to paper over debt problems and to downplay bad statistics, means that the Chinese economy will be ever more tied to the government, unable to go through the type of “creative destruction” necessary to put it on a solid footing.

Which in turn means a massive political headache, and maybe worse, for the Chinese Communist Party. The party has kept its grip on the population through an agreement that it will provide economic growth in exchange for political freedom.

The people trusted that a competent government would keep its part of the bargain, and for the past 30 years, it has -- if unevenly.

Now, however, the competency of the government is at stake. The autocratic technocrats who control China can’t afford to lose their legitimacy.

That’s one reason for the kitchen-sink approach to the stock collapse.

Xi Jinping’s government is already the most repressive China has seen in a quarter-century. Squashing any dissent in the coming days will be the counterpart to trying to keep China’s house-of-cards financial system from imploding.

Shanghai’s stock market most likely won’t totally collapse. But its turbulence is a sign that China, and the world, is in for a bumpy ride.

Michael Auslin is a resident scholar and the director of Japan Studies at the American Enterprise Institute (AEI), where he specializes in Asian regional security and political issues. Before joining AEI, Auslin was an associate professor of history at Yale University. His articles can be read here

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