is the chinese dragon losing fire?

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Is the Chinese Dragon losing fire? The great Chinese Dragon tumble on Monday led to a furore in almost all the leading markets of the world with all of them ending in deep red. The Shanghai Composite Index ended trade on Monday down 8.49 percent, after all of the yearly gains were wiped out of the market. Let’s start decoding what led to this Monday Mayhem. A quick background… In 35 years from 1979 to 2014, the Chinese economy has grown by 10% per annum and doubled in size every 8 years, relative to the US economy. The subsequent governments in China worked on “decollectivization” of individual farm lands which helped improve agrarian productivity to help feed a burgeoning city population. Then they set up innumerable micro and small enterprises in the manufacturing sector and opened new industrial zones in Pearl River Delta in South China (adjacent to Hong Kong and Macao) and in the Fujian Province (close to Taiwan). The Economic Boom Gradually, foreign investments surged into China primarily due to availability of cheap labour, and also due to the succession of Hong Kong into Chinese mainland in 1997 and China’s subsequent entry into the WTO also added to the cause. Chinese Government ensured competitiveness of Chinese goods by repeated devaluation of its currency from 1.5 Yuan to 1 US$ in 1978, to 4.8 Yuan to 1 US$ in 1990, to 8.3 Yuan in 1994, to 10 Yuan very recently. One example of a successful manufacturing enterprise from China is Foxconn, manufacturer of iPhone, which is now setting up its manufacturing units in India. The Problem starts With a devalued currency and manufacturing glut, exports surged to unprecedented levels. Over time, while manufacturing continued to power ahead, unfortunately, the global demand and

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Page 1: Is the Chinese dragon losing fire?

Is the Chinese Dragon losing fire?

The great Chinese Dragon tumble on Monday led to a furore in almost all the leading markets of

the world with all of them ending in deep red. The Shanghai Composite Index ended trade on

Monday down 8.49 percent, after all of the yearly gains were wiped out of the market. Let’s start

decoding what led to this Monday Mayhem.

A quick background…

In 35 years from 1979 to 2014, the Chinese economy has grown by 10% per annum and

doubled in size every 8 years, relative to the US economy. The subsequent governments in

China worked on “decollectivization” of individual farm lands which helped improve agrarian

productivity to help feed a burgeoning city population. Then they set up innumerable micro and

small enterprises in the manufacturing sector and opened new industrial zones in Pearl River

Delta in South China (adjacent to Hong Kong and Macao) and in the Fujian Province (close to

Taiwan).

The Economic Boom

Gradually, foreign investments surged into China primarily due to availability of cheap labour,

and also due to the succession of Hong Kong into Chinese mainland in 1997 and China’s

subsequent entry into the WTO also added to the cause. Chinese Government ensured

competitiveness of Chinese goods by repeated devaluation of its currency from 1.5 Yuan to 1

US$ in 1978, to 4.8 Yuan to 1 US$ in 1990, to 8.3 Yuan in 1994, to 10 Yuan very recently. One

example of a successful manufacturing enterprise from China is Foxconn, manufacturer of

iPhone, which is now setting up its manufacturing units in India.

The Problem starts

With a devalued currency and manufacturing glut, exports surged to unprecedented levels. Over

time, while manufacturing continued to power ahead, unfortunately, the global demand and

Page 2: Is the Chinese dragon losing fire?

consumption of Chinese manufactures hit a new low. China started experiencing a crisis of over

accumulation; i.e production far outstretches consumption both in the international and in the

domestic markets, especially in cement, steel, aluminum and shipbuilding.

The situation deteriorates

The Chinese economy in 2007 found itself to be uncoordinated, unbalanced and unsustainable.

In 2009, thousands of companies shut shop leaving 20 million workers unemployed. By the time

it was 2013, there were ample Government stimulus programs in place and shadow-banking

networks active. (It has been common practice for investment banks to conduct many of their

transactions in ways that do not show up on their conventional balance sheet accounting and so

are not visible to regulators or unsophisticated investors.) Growth rates were upped, but it left a

toxic legacy. There was indebtedness all around, insufficient consumption of manufactures, and

to top it all the property bubble deflated in 2014. Central Government then encouraged investors

to flood the stock market with money, and by June 2015, the Stock Exchange had soared by

150%. But, since this was in complete dissonance with the real economic situation, and with

huge numbers doing margin trading, it didn’t take long for the stock market to crash, which it did

on the 12th of June, 2015 and there was rout of 4 trillion $ of value from Chinese stocks. These

developments in China will surely have had repercussions all over the world and for a long time

to come!

And, eventually on 24 August, the worst fears of most of the world economists were realized

when the Shanghai market tanked and took all the major markets with it.

-Ms. Monica Mor

Senior Faculty, INLEAD