The financial crisis in China took an ominous turn for the worse overnight as investors dumped shares despite government-led measures to stabilize prices. Leading Chinese stock markets fell three to four percent as local investors joined foreigners in a mass exit from what, until recently, had been one of the world's hottest markets. The rout left government officials with egg on their faces; over the weekend officials had orchestrated a series of steps aimed at stabilizing a market that had lost almost a third of its value in three weeks. The Shanghai and Shenzhen markets stabilized Monday, though Hong Kong continued to sell off. On Tuesday, the bears were back and Chinese markets fell across the board through midday trading. With trading in the shares of more than 650 companies suspended, the rout could have a long way to go.
Nobody knows where this is headed. China's markets (still up more than 80 percent over year-ago levels) were due for a major correction, and the warning signs of an economic slowdown have been flashing for some time. On top of that, China's export-oriented growth model has long since reached its sell-by date, and the government has been trying to engineer a complex and risky transformation, basing (slower) growth on domestic consumption more than on an ever-accelerating flood of exports.
The transformation is clearly turning out to be more difficult than hoped. Powerful vested interests want to keep the old economic model spinning, and policymakers clearly fear the possibility that efforts to slow 'excessive' growth will work too well and too quickly. Torn between their knowledge that the economy needs to change and fear that change will be too fast or too rough, China's policymakers have looked uncharacteristically uncertain, now stepping on the brake, now pushing the accelerator to the floor.
The example that haunts China is Japan, where years of rapid growth culminated in a devastating stock market crash and a generation of economic stagnation. There are differences between the two Asian economic superpowers, but in both cases the combination of a financial sector that had been grossly distorted by political forces and a large and powerful corporate sector that was wedded to export-oriented growth left policymakers with fewer and fewer good options. But Japan had two big advantages when long term stagnation set in. Its democratic institutions provided safety valves for public discontent, and it had reached a level of affluence that left many Japanese reasonably contented even as growth slowed and stocks crashed.
China's position is more precarious, and even a relatively short term interruption in the Chinese economic miracle could be hard for the authorities to manage.
A bad month in the financial markets isn't the end of the world, but the longer this goes on the more people in China and abroad will begin to wonder if something more fundamental is at work. From the standpoint of geopolitics, economic trouble in China would be an earthquake that sends a tsunami all over the world. The growth slowdown in China has already contributed to falling oil and commodity prices worldwide; from Russia to Brazil to Nigeria and South Africa, countries who profit from energy and raw materials exports have already seen their economies sag. Many of China's neighbors are also exposed to the consequences of a weaker Chinese economy. Beyond that, one can only speculate. Will China respond to economic weakness by bellicosity, using nationalism to distract locals from their financial troubles, or will it abandon its geopolitical ambitions to focus on solving its problems at home?
Unfortunately, China's stumble comes at a bad time globally. The EU remains paralyzed and hamstrung by its euro problems. The United States is not, to put it mildly, managing its foreign policy portfolio particularly well. All the world's major economies still depend on the loosest monetary policies in the history of civilization. The recovery from the financial crisis of 2008-9 remains fragile. The world does not need more shocks; it is beginning to look as if we could be about to get a particularly nasty one.