The global economy has gone through massive financial turmoil every seven years.
All financial crises stem from debt.
Prior to the 1997 Asian financial crisis, Southeast Asian countries borrowed huge amounts in US dollars in the expectation their own currencies would appreciate.
However, their currencies weakened sharply as their economic growth moderated, and their debt burden surged.
The 2008 financial crisis resulted from the subprime mortgage crisis.
Many banks suffered when leverage-driven property prices started a free fall.
They were already grappling with solvency issues when the collapse of Lehman Brothers triggered a global crisis.
The cause of the European debt crisis was eurozone countries failing to pay back debt and facing a default risk.
Now the market is worried because China inflated its debt massively over the past several years by rolling out an economic stimulus package after the 2008 financial crisis.
By mid-2014, China’s debt already accounted for 282 percent of its gross domestic product.
The ratio is even higher than the 269 percent of GDP in the United States, which has been focusing on deleveraging in recent years.
Will the high debt ratio lead to a hard landing for China’s economy?
China has a much higher savings rate than western countries, and there is little chance of a broad-based default given that external debt represents less than 10 percent of its total debt.
Also, Beijing holds nearly US$1.3 trillion in US treasuries, which it could dump if necessary.
There won’t be a global financial crisis in the absence of unexpected policy or intervention measures.
The key to winning a game is to focus on the team rather than the scoreboard.
Over the past year, Beijing thought it could stimulate economic growth through a bull stock market and help companies to raise funds at high share prices.
However, the tactic did not work and even increased systemic risk.
The rapid run-up in the market lured in capital from individuals and firms.
Investors ramped up their leverage.
Now the market crash has not only weighed on private consumption but also on business investment.
The government has ordered firms to rescue the market at an expensive level.
Domestic funds and brokerages have bought stocks as commanded and suffered losses.
China had hoped for big steps in financial reform this year, including the inclusion of the renminbi in the International Monetary Fund’s special drawing rights basket of currencies, and the inclusion of A shares in a key MSCI index.
However, the blatant government intervention in A shares has made global investors skeptical.
Shanghai-Hong Kong Stock Connect was expected to narrow the price gap between the H shares and A shares of dual-listed firms.
However, the gap has kept widening, as A shares have not been allowed to fall to their natural levels.
Foreign investors have been scared away.
There is still a long way to go for China’s stock market to become integrated with the global market, and investors should rethink the valuation of financial intermediary stocks.
It’s always been a risky move to try to boost the economy through the equity market.
The government should return to the right track and rely on economic reforms to support the stock market.
The most dynamic sectors — like internet technology, home appliances, retail and natural gas — are dominated by private companies.
The government should open up the market and offer a fair playing field to allow firms to compete and innovate.
The key is to focus on teams rather than the scoreboard.
This article appeared in the Hong Kong Economic Journal on Aug. 28.
Translation by Julie Zhu
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