By Simon Denyer and Ylan Q. Mui,
BEIJING — Just a week ago, Chinese President Xi Jinping sounded a triumphant note as he rang in the new year, touting the economy’s continued growth and financial reforms that have elevated the country’s currency among the world’s elite.
In a state-televised address, Xi sat behind an imposing wooden desk, hands clasped, and declared that “the general public has enjoyed the increasing sense of gain.”
But the first week of 2016 has brought only chaos. Chinese stocks have fallen nearly 12 percent, sending Wall Street into a tailspin. On Thursday, the Dow Jones industrial average fell nearly 400 points after paring earlier losses that put it in correction territory.
China first attempted to stabilize the market and subsequently stanch the losses with a series of interventionist moves, introducing a circuit-breaker system at the end of last year, then buying shares and restricting selling this week when that didn’t work. But the hasty moves seemed to exacerbate investors’ worst fear: that policymakers in Beijing are in over their heads.
“We should be worried rather than calmed by the moves that we have seen so far,” said Eswar Prasad, a professor at Cornell University and former head of the International Monetary Fund’s China division. “The moves taken by the Chinese government so far involved some heavy-handed and direct market intervention rather than any significant confidence-building measures.”
China is one of the main drivers of the global economy — particularly since the financial crisis left the United States and Europe hobbled by slow growth and weak inflation. China’s fate is also closely intertwined with those of emerging markets in Latin America and Africa, which feed China’s once-voracious appetite for raw materials such as copper and iron ore. But the world’s second-largest economy is slowing as policymakers turn to consumer spending rather than manufacturing and exports to fuel growth. After years of logging double-digit increases, the pace of economic expansion slowed to just over 7 percent in 2014 and probably missed that mark last year.
The breakneck pace was never sustainable. Officials boosted growth by over-investing in factories and infrastructure, moves that have resulted in a glut of exports and idle capacity. The ripple effects are being felt in China’s trade and investment partners from Brazil, which has fallen into recession, to Zambia, where plummeting copper prices have shut down local mines. And in Beijing, government officials accustomed to years of excess must figure out how to manage a decline — and many investors remain skeptical of their ability or desire to do so.
Speaking at an economic forum in Sri Lanka, influential global investor George Soros said China has a “major adjustment problem” on its hands and compared the current volatility to the turmoil in 2008. “I would say it amounts to a crisis,” he said, according to Bloomberg News. “When I look at the financial markets, there is a serious challenge which reminds me of the crisis we had in 2008.”
The swings in Chinese and global markets, as well as policymakers’ often-muddled responses, echo the volatility endured over the summer. Beijing’s announcement in August that it would let its currency float more freely sent equity markets plunging around the world. Many investors suspected the move was driven by a desire to devalue the Chinese yuan to prop up flagging exports, rather than open up financial markets.
But China’s moves seemed to be validated later in the year. During a trip to Washington in September, Xi promised President Obama that his country would not devalue its currency. A few months later, the International Monetary Fund approved the yuan as a global reserve currency, an elite status previously held only by the pound, the euro, the dollar and the yen. A Chinese newspaper known for its strident nationalism equated the decision with a “coronation ceremony” for China as it ascends in the new world order.
This week, the skepticism returned. China’s central bank surprised investors by lowering the midpoint for trading the yuan by half a percentage point, the lowest rate since March 2011. In addition, officials revealed that the country’s foreign exchange reserves posted the biggest annual drop on record last year. In December alone, the central bank spent more than $100 billion supporting the yuan.
The measures raised new concerns that Beijing remains loath to relinquish control of its currency, particularly as the workhorses of China’s economy — manufacturing and construction — contract more quickly than anticipated. “The market is beginning to question the ability of economic policymakers to manage this transition in a smooth manner,” said Olin Wethington, U.S. special envoy to China under President George W. Bush. “That’s a significant component of what’s going on.”
Case in point: the circuit-breaker system introduced this week that stops trading when losses hit a set limit, an ill-conceived attempt to foster market stability. The CSI 300 index of shares in Shanghai and Shenzhen traded Thursday for only 14 minutes before the first circuit breaker kicked in, forcing a 15-minute halt to trading after shares fell 5 percent. But instead of calming the market, the suspension only caused more panic. When trading reopened, prices fell further as traders rushed to sell what they could, triggering a shutdown for the rest of the day.
The market remained volatile Friday. After swinging between gains and losses, stocks were up more than 2 percent over Thursday’s closing.
Wu Xianfeng, president of Longteng Asset Management in Shenzhen, said the system was “only accelerating and escalating the panic in the market,” and he accused the authorities of not listening to investors. “You can’t just work behind closed doors and act blindly,” he said.
By late Thursday, the China Securities Regulatory Commission was forced into an embarrassing turnaround, as it announced that it would suspend the new mechanism beginning Friday. “Currently, the negative effects . . . are larger than positive effects,” CSRC spokesman Deng Ge said in a statement carried on state media.
Some analysts saw a silver lining in Beijing’s reversal. Acknowledging error is unusual within China’s heavily propagandist communist government but critical to solving the problem.
“The development of an emerging market is a process,” Wu said. “Policymakers can test various policies, but if they find one is incorrect, they must have the courage to correct the mistake.”
What remains unclear is how tightly linked China’s stock market is to the real economy. Most of the trades are made by individual investors rather than the large institutions that often dominate Wall Street. The government has set a target of 6.5 percent growth in 2016, and despite widespread distrust of official data, few analysts are predicting a dramatic collapse.
“The question is whether the stock market is the canary in the mine or the canary in the field,” said Edwin Truman, senior fellow at the Peterson Institute for International Economics. “We don’t really know.”
Mui reported from Washington. Emily Rauhala in Beijing contributed to this report.
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