China’s Market Plunge Far From Over

China’s economic prospects are the best that they have been in two years. The World Bank expects its GDP to rise 10.5% this year. There are early signs of inflation, but those may be the result of the $585 billion stimulus package the central government put in place early in 2009. That investment is over. Manufacturing activity has rebounded from the depth of the recession.

In the midst of all this, the Shanghai Composite fell another 5% overnight to 2,559.93, its low point over the last year. The index peaked at 3,471 last August. It hit 5,903 in October 2007.

If stock market activity is indeed a forecast of an economy six months out, China is in grave trouble. It seem improbable that such a robust economy could disintegrate so quickly, save for the fact that there is recent precedent for it in 2008 and 2009 in the US, UK, Japan, and EU. The causes for a drop in China economic activity are growing.

China’s risk in Europe in generally supposed to be the growing value disparity between the yuan and the euro which makes it more expensive to sell goods in the Continent. But, the trouble is more complex than that. Austerity measures put in place by EU governments could be regressive which may damage GDP recovery. The demand for Chinese exports at any price could falter.

There are still concerns by some economists that the liquidity pumped into the market has cause bubbles in real estate. That may be true, because the trouble in the stock market could undermine the purchasing power of the Chinese middle classes. If so, the demand for real estate my level of perhaps drop.  That could indeed pull some of the capital supporting the market out of the sector.

And, finally, there is the threat of a trade battle between the US and China. It seemed more likely three months ago than now. The rhetoric about the American government labeling China a “currency manipulator” calmed after Treasury let the date for the judgment lapse in mid-April. But the struggle will escalate again if European economies collapse and the US and China are competing for a shrinking market for their exports.

China is not in any real economic trouble now. But, the reasons it could get into trouble may be different from those supposed. A rapid shrinkage in Europe’s GDP and ability to buy imports may be the thing that does the most to undermine the economic expansion in the People’s Republic.

Douglas A. McIntyre