Such was the impact of the recent stock crash that crippled the Chinese economy.
Most important was Black Monday on August 24, which saw an 8.5 percent decline in the Shanghai Composite – the worst single-day fall in eight years. The next day was no better, as the stocks closed 7.6 percent lower.
The first statement indeed held true when the Dow Jones took a 1,000-point hit the same morning. A similar wave of sudden stock price drops reflected all over the globe. While big economies like the U.S. and India recovered soon enough, other smaller countries, mostly those wholly dependent on China’s exports, like several countries in Africa, suffered more significant losses.
This Chinese stock crash was not so sudden, though. It was over a year in the making. It was a product of the Politburo trying to juggle too many things at once – things like shifting from an investor-driven to a consumer-driven market while dealing with stringent anti-corruption reform. A spiral of these events and others led to the government making too many intrusions into the People's Bank of China and the other three state-owned banks. This led to an unstable yuan, which led to some risky counter-measures, which eventually backfired.
The Politburo then forced the PBC to lend money to the population, sometimes even at low interest rates. This led to a lot of individual investors putting money into the stock markets, stabilizing the yuan. All of these changes were made possible because the primary investors in China are individual investors, making up about 85 percent of the trades. On top of that, A-shares are blocked for foreign investors, which results in the population of China primarily defining the fluctuations in the market. This policy was an attempt to replace debt with equity.
The trick worked, and the yuan started getting better – so much better that the government had to decide to implement changes to bring it back to stable so as not to hurt export rates. This led to a major devaluation of the yuan on August 11, while the already-strong dollar became even stronger. With this devaluation combined with some others, the public anticipated fear and started selling on an extensive level.
To prevent a catastrophic economic crash, the Chinese government had started implementing some regulations at the beginning of the year. The government was persistent that the brokerages invest vigorously into the stock market, funded by state-owned banks. State-owned media outlets kept encouraging individual investors to keep investing. Short selling was also limited under the threat of arrest. While most of these things were already starting to take effect in the second quarter, it wasn’t until July, when the stock price decline was so bad, that around 1,400 firms suspended trading of stocks to protect their assets.
All of this led to Black Monday and Black Tuesday. The tipping point, though, was when the government failed to announce plans to cut the bank reserve ratio or interest rates. As a result, a slight panic ensued and mud-slided into a huge crash. These were the two days when all screens of the theater-like brokerage firms turned red, and the investors watched their money evaporate.
A lot of finance gurus are frowning on China’s actions leading to Black Monday, stating that there are a lot of unknowns. I believe that, even as a desperate measure, it was still a good bet to stabilize the falling growth rate. Of course, the series of unfortunate events leading to the ultimate crash could have been avoided. But these so-called unknowns are by western perspectives and we differ from the east in colossal ways.
What China needs to keep on doing, even after this knock-down, is to continue its reforms so that it can initiate its transition from an investor-driven economy to a consumer-driven economy. The most important action to take would be to balance out the investors pouring in to already-well-funded sectors like technology, manufacturing and finance and shift the focus of foreign investments to the dwindling sectors like public funds, healthcare or education.
China is still predominantly unidirectional when it comes to foreign exchanges, with most of its economy defined by exports. If China wants to implement a bidirectional system where the imports make some money too, it needs stringent reforms. Especially ones which work around the dysfunctional and highly corrupt government, which often proves to be a hindrance.
One single day of plummeting stock markets can never define a country’s economy. But the only way China can bring change, slow down its declining growth rate and prevent future crashes is by altering the socio-political and economic structure from within.