Opinion piece by Hon. Peter Costello AC, Chair of the Australia-China High Level Dialogue and Chair of the Future Fund Board of Guardians
Australian investors should not focus on Greece at the expense of China, which is the main event.
Measured by purchasing power parity, China became the world’s largest economy in 2014. China is Australia’s largest export destination. We import more from China than any other country. A decade ago, the rise of China began to boost our Terms of Trade. The slowing of China means they are heading back down. They are not as low as they were in 2005, but not as high as when they peaked in 2010.
China’s stock market has seen enormous rises, with its Shanghai Composite index, at its 2015 peak, 144% higher than at the start of 2014. The market has fallen significantly on eight of the past ten trading days and is around 30% off that peak.
Some will take the view that these falls presage bad news for China’s real economy- for growth, employment and ultimately Chinese trading partners, such as Australia, and a good part of the rest of the world. It could. But the trouble is that China cannot be analysed and understood in the way we analyse modern industrial market economies.
In western countries we can go back and analyse data over a Century to see how periods of Stock Market stress have affected growth, income, and employment in periods like the Crash of 1929, the Crash of 1987, the Tech Wreck of 2001 or the Financial Crisis of 2008. China doesn’t have a Century of experience to draw on. It has financial markets that have only recently opened up. Its population is entering those markets for the first time with limited financial education and experience.
On the flip side China’s authorities have much more capacity to intervene in the market than western counterparts. China benefits from US$3.7 trillion in foreign exchange reserves. It has the capacity to direct the activities of large State Owned Enterprises and it has been prepared to lend money and act to support markets.
We have seen this in recent days as authorities have banned senior executives and large shareholders from selling stocks, provided credits to brokers to buy stocks, and secured commitments from State Owned Enterprises not to sell shares and to start purchases when shares are seen as undervalued.
Not only does China have significant firepower, it has demonstrated that it can deploy it quickly and effectively. China successfully navigated the Asian financial crisis. It showed great skill responding to the Financial Crisis of 2008.
The volatility in Chinese stock markets and the Government response raises a number of important questions. It is possible the Chinese leadership will become more cautious in pursuing market liberalisation. Will authorities be prepared to accept the kind of corrections which are parcel of a liberal market economy? If not will it ever truly embrace a market economy?
How China deals with these questions will have a significant impact on its future and, consequently, on Australia, its economy, exporters and trade relations. No country has ever liberalised its economy without suffering difficult adjustment consequences. There will be steps forward and some reverses.
For investors, it is important to remember that if a market rises to unsustainable levels, it will correct. It is important to remember that the transmission mechanisms between the financial sector and the real economy are different in China to those of advanced liberal economies. China is a huge economy. We should focus on developments as they unfold and as the Government responds. It warrants close and careful attention.
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