CHINAS FINANCIAL CRISIS

CHINA'S slowdown crisis has already created shockwaves and market turmoil across the world
but experts fear that far worse is yet to come.
The soundtrack to a financial meltdown was the yelling of traders on the floor of a financial
exchange. Now it is more likely to be the wordless hum of servers in data centers, as algorithms
try to match buyers with sellers. But every big sell-off is gripped by the same rampant, visceral
fear. The urge to sell overwhelms the advice to stand firm.
Stomachs are churning again after Chinas stock market endured its biggest one-day fall since
2007; even Chinese state media called August 24th Black Monday. From the rand to the
ringgit, emerging-market currencies slumped. Commodity prices fell into territory not seen since
1999. The contagion infected Western markets, too. Germanys DAX index fell to more than
20% below its peak. American stocks whipsawed: General Electric was at one point down by
more than 20%.
Rich-world markets have regained some of their poise. But three fears remain: that Chinas
economy is in deep trouble; that emerging markets are vulnerable to a full-blown crisis; and that
the long rally in rich-world markets is over. Some aspects of these worries are overplayed and
others are misplaced. Even so, this weeks panic contains the unnerving message that the malaise
in the world economy is real.
Around $5 trillion has been wiped off global equity markets since the yuan devalued earlier this
month. That shift, allied to a string of bad economic numbers and a botched official attempt to
halt the slide in Chinese bourses, has fuelled fears that the worlds second-largest economy is
heading for a hard landing. Exports have been falling. The stock market has lost more than 40%
since peaking in June, a bigger drop than the dotcom bust.
Yet the doomsters go too far. The property market is far more important to Chinas economy than
the equity market is. Property fuels up to a quarter of GDP and its value underpins the banking
system; in the past few months prices and transactions have both been healthier. Chinas future
lies with its shoppers, not its exporters, and services, incomes and consumption are resilient. If
the worst happens, the central bank has plenty of room to loosen policy. After a cut in interest
rates this week, the one-year rate still stands at 4.6%. The economy is slowing, but even 5%
growth this year, the low end of reasonable estimates, would add more to world output than the
14% expansion China posted in 2007.

China is not in crisis. However, its ability to evolve smoothly from a command to a market
economy is in question as never before. Chinas policymakers used to bask in a reputation for
competence that put clay-footed Western bureaucrats to shame. This has suffered in the wake of
their botchedand sporadicefforts to stop shares from sagging. Worse, plans for reform may
fall victim to the governments fear of giving markets free rein. The party wants to make stateowned firms more efficient, but not to expose them to the full blast of competition. It would like
to give the yuan more freedom, but frets that a weakening currency will spur capital flight. It
thinks local governments should be more disciplined but, motivated by the need for growth,
funnels credit their way.
Fears over China are feeding the second worrythat emerging markets could be about to suffer
a rerun of the Asian financial crisis of 1997-98. Similarities exist: notably an exodus of capital
out of emerging markets because of the prospect of tighter monetary policy in America. But the
lessons of the Asian crisis were well learned. Many currencies are no longer tethered but float
freely. Most countries in Asia sit on large foreign-exchange reserves and current-account
surpluses. Their banking systems rely less on foreign creditors than they did.
If that concern is exaggerated, others are not. A slowing China has dragged down emerging
markets, like Brazil, Indonesia and Zambia, that came to depend on shovelling iron ore, coal and
copper its way (agricultural exporters are in better shape). From now on, more of the demand
that China creates will come from servicesand be satisfied at home. The supply glut will weigh
on commodity prices for other reasons, too. Oils descent, for instance, also reflects the extra
output of Saudi Arabia and the resilience of American shale producers. Sliding currencies are
adding to the burden on emerging-market firms with local-currency revenues and dollardenominated debt. More fundamentally, emerging-market growth has been slowing since 2010.
Countries like Brazil and Russia have squandered the chance to enact productivity-enhancing
reforms and are suffering. So has India, which could yet pay a high price.
The rich world has the least to fear from a Chinese slowdown. American exports to China
accounted for less than 1% of GDP last year. But it is hardly immune. Germany, the European
Unions economic engine, exports more to China than any other member state does. Share prices
are vulnerable because the biggest firms are global: of the S&P 500s sales in 2014, 48% were
abroad, and the dollar is rising against trading-partner currencies. In addition, the bull market has
lasted since 2009 and price-earnings ratios exceed long-run averages. A savage fall in shares
would spill into the real economy.
Ageing bull
Were that to happen, this week has underlined how little room Western policymakers have to
stimulate their economies. The Federal Reserve would be wrong to raise rates in September, as it
has unwisely led markets to expect. Other central banks have responsibilities, too. Money

sloshing out of emerging markets may try to find its way to American consumers, leading to
rising household borrowing and dangerousand familiardistortions in the economy. So
Europe and Japan should loosen further to stimulate demand.
Monetary policy is just the start. The harder task, in the West and beyond, is to raise productivity.
Plentiful credit and relentless Chinese expansion kept the world ticking over for years. Now
growth depends on governments taking hard decisions on everything from financial reforms to
infrastructure spending. That is the harsh lesson from Chinas panic.