The Chinese Stock Market

The press has recently devoted a lot of time to the Chinese stock market and the devaluation of the Chinese yuan. While this seems like a problem a world away, it can have a serious impact on the United State’s and global economy.

The Chinese economy has fueled a lot of the growth in the American economy and increased the buying power of many low to middle-income consumers. By importing less expensive goods from China, American’s can buy more products with the dollars they have thereby increasing their purchasing power. This relationship was shown in a paper published by the economist Christian Broda of valuewalk.

Broda researched the effect of low-priced goods sold through such retailers as Target and Wal-mart to prove that lower cost imported goods helped grow the American economy by an average of $10 billion dollars a year over the study period. Broda is a Ph.D. in Economics having graduated from MIT and went on to become a tenured Professor of Economics at the University of Chicago. Recently Broda left academia to become the Managing Director of a New York City-based hedge fund, Duquesne Capital Management.

In devaluing the yuan (also known as the renminbi), China made their exports slightly more expensive to the rest of the world. However, by carefully calculating the devaluation, the Chinese People’s Bank didn’t make the additional cost of their exports so much to appreciably impact the level of exports, but also not enough to make foreign investors want to exchange their yuan for other currencies causing a capital flight from the country.

One of the reasons for the devaluation is China’s painfully slow process to realign its economic house from an emerging economy. Also, China has long sought the objective of having the yuan be including in the International Monetary Fund’s basket of preferred currencies along with the US dollar, Euro and Japanese Yen. The I.M.F. has deferred that decision until at least next year.

While stock markets across the globe reacted negatively, the Chinese market is still about 40% above its value this time last year. Investors are notoriously skittish concerning any major financial news and even though China’s devaluation was previously announced and the amount of the devaluation was relatively small (1.9%), investors still reacted with a sell-off. Other factors contributed to the market’s decline like China’s slowing exports, overall sluggishness in their internal economy, and its failure to provide additional enticements for future capital investments.

Other country’s central banks will also be put under pressure to devalue their currencies so that their own export markets will not become uncompetitive against China’s. The argument of China’s export protection will probably become a big political talking point in the upcoming US elections.

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