What the hell just happened in China? – EXPLAINER

This year, through the entirety of 2016 (short it may be), the Australian Securities Exchange has not posted a gain, demonstrating the danger of trying to hold onto a dragon’s tail.

You may have noticed that the ASX 200 hasn’t had a great time of it recently. Although it’s up in early trade at the time of writing, the ASX has shed about 6.15% for the year.

Shares are currently at approximately 2 1⁄2 year lows, hardly a great start to the year for the bourse.

Financial news reports suggest that the market is down on China concerns – but what concerns?

What is China doing (or not doing) to spook Australian investors.

Interconnected economies

The first thing to note is that the Australian and Chinese economies are linked, mostly one way. The Chinese stock exchange may not tumble if the Australian economy goes backward, but the Australian economy is very susceptible to movement in China.

This is because Australia sells a lot of raw materials to China, and increasingly does a lot of business with Beijing.

While China was booming and manufacturing and construction in the country were up, Australia did a roaring trade.

It was the whole reason Australia experienced a mining boom. If China wasn’t buying up all the iron ore, we wouldn’t have been speaking so glowingly about the resilience of the Australian economy, and the country would have felt the global financial crisis even harder than it did.

What we’re seeing now is a pullback in the level of growth and manufacturing activity in China.

When those indicators go backward, it is perceived there is a lack of demand for Australian materials, and the companies involved in the manufacture and selling of those materials slip backward.

Unfortunately, the Australian economy as a whole is weighted towards exports of raw materials to China.

While times are good Australia receives the full benefit of Chinese growth, but as forecasts become gloomier, Australia is more affected than other countries.

It’s a double-edged sword.

So what in particular happened?

Chinese shares have been on the downslide for quite a while, capturing the trend of slowing growth.

It’s important to note that growth in China is still the envy of many an economy, but going backwards is rarely a sign of strength.

Because of the heavy control the Chinese government has on the sharemarket, it has done things such as close the market after a slide of 7% for the trading day to limit the damage.

China may be trying to protect its economy, but it hardly inspires confidence from international investors.

However, the sharemarket shocks around the world had little to do with securities and more to do with currency.

Last week China moved to cut the value of the yuan against US currency, essentially by allowing more money from the Chinese central bank to flow onto the market.

There have long been fears of a so-called ‘currency war’ being waged by China.

Instead of allowing its currency to float in an open market, the Chinese government wants to keep a tight control on the value of its currency.

So when the yuan falls in value – it’s a very calculated move.

To be fair, China did step in and buy back more currency on Friday and Monday, but the damage had already been done.

So why does China want to de-value its currency?

The aforementioned slowdown in manufacturing in China has hit hard, leading to slower growth rates.

While efforts have been made to transition China to more of an import economy, China remains an economy which is very much pegged to exporting goods to the rest of the world from a plethora of factories.

Imagine you’re an overseas buyer.

Imagine you buy something from a Chinese factory for 100 yuan (just as an example). You pay for it for $15.22 US dollars.

Now, imagine the Chinese government stepped in and decreed by its actions that 100 yuan was now worth $13 US dollars.

It gives you, the buyer, an incentive to keep on buying from that Chinese factory. After all, you’re getting a better deal now.

So while the Chinese government may be able to manufacture (pun intended) a spike in manufacturing activity because of increased demand, the action is so transparent that overseas markets can’t help but notice.

It’s an obvious signal that the Chinese government is worried about a slowdown in its economy. Hard economic data on China can be a little bit hard to find (and to verify), but actions speak louder than words.

It also raises the fear that competitors to China may devalue their own currencies to compete in the global market for the buyer’s dollar.

How the market comes into it

So again, investors get the sense that the Chinese manufacturing sector is going backward, leading to the interventionist action.

If the Chinese government is taking this action, then it must be worried about the state of its economy.

Investors, being human after all, see the negative instead of taking advantage of the expected spike in manufacturing the move may make.

They sell on the negative sentiment, and that’s how we end up in a position where we are today where by some accounts, the local market has wiped off $100 billion in value since the start of the year.

At the time of writing it looks like the local market will pare back some of the losses, but it’s hardly a great start to 2016.