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  • Mathieu Provencher

China is losing control

(picture taken from Wix's library)

Hi Guys! It is that time again, that wonderful moment when I tease your brain cells (or at least some of them I hope) with real-life examples of Economics!!!!

Today I will talk a bit about speculation, more specifically related to the recent stock market crash in China. We hear a lot about "speculators" in Economics so let's start by a few characteristics that define who they are:

(1) Speculators can be people, firms, or countries; (2) They take financial decisions based on what they believe will happen; (3) Lastly, they tend to have an influence on the market, either as individuals or as a group.

Now, is speculation bad? Well... as you all know I have to give you my favorite answer of all times: It Depends!!!

Speculation is quite important for markets to operate properly. Speculators that think a company will do better in the future can lend money to that firm in the hopes of making some profits out of that (by buying their stocks for example). That helps the firm develop their products and it brings more choice to us, the consumers. If speculators are well informed and smart, they will be able to identify the "good" investments and thus help society provide better and better products.

However, speculators can also speculate not on the product nor on the firm, but on stock value itself... these speculators will simply look at movements of stock values (or base themselves on some magical understanding of the universe) in order to invest. They tend to buy when a stock is increasing in value (not even bothering to inform themselves about that company) and sell when the value is decreasing... creating much more variability than there would be otherwise. I would qualify these "casino speculators" as bad ones. Unfortunately, these types of investors are more and more common and they control higher and higher proportions of our markets... and that worries me quite a lot.

Back to our context: China. The Chinese economy is probably growing slower than many people had anticipated. I say "probably" because numbers from China are fictitious... people believed that the last fictitious numbers from china would be higher than the actual fictitious numbers the government showed (these numbers are made-up but we don't really know to which extent).

IF the Chinese Economy has indeed grown slower than before, it could mean that China would import less from other countries. A number of commentators argue that they would import less inputs because they make less things and they would import less because Chinese consumers are a bit less rich and less confident.

This slowdown would lead to lower demand for commodities, which would in turn loose value (and hurt countries like Peru that sells them). Also, lower economic activity will make people uncertain about the profitability of Chinese firms, which can lead to much lower demand for their stocks, and thus create a stock market crash.

Let's see if any of that happened... this month, the Chinese government did show growth numbers that were lower than they had anticipated before (although no one really knows, not even the Chinese government), which was followed by lower commodity prices (in one month, light crude oil lost close to 17% of value, gold close to 8%, copper close to 10%, and silver close to 7%) and a stock market crash in China (a loss of value of close to 30% in 18 days).

Does it make Economic sense? Not really actually!!!!! China did not shrink, like Brazil seem to have done (my next topic), it still grew... but just a bit slower than anticipated... perhaps! With China growing at let's say 5%, they would buy more commodities than before, NOT less, and their firms would bring more production (and perhaps profits), again NOT less.

These are the movements of short-term speculators that have no clue what they are doing. These investors very often have small accounts and they will move very often from one stock to the other or just sell everything they have at the slightest sign of losses. The problem is that there are millions of such investors, and together they have a big influence on stock and commodity values.

In this case, I would say that these speculators are something bad for the economy. I had started looking into this phenomenon around 2006 or so and I felt at the time that the world economy was moving towards a potential crash... then the 2007 financial crash happened, completely unrelated to what I was looking at (no I did not see that one coming, I was busy looking at something bigger). I feel that we are now moving back towards that risky situation I was looking at. If you thought a financial crash in the US and UK was bad, wait and see how that one will blow our savings (and retirements) away!

On 15th of August, I wrote: Interesting development in China in relation to speculation. China devaluated their currency substantially this week. They are again trying to control the markets and to soften the blow they received in the stock markets a bit earlier (mentioned in the main post). It looks to me that the Chinese government is loosing its ability to micromanage their economy... once you let the markets in, you need to accept that you will loose a certain amount of control. Chinese leaders have been obsessed with control and stability for so long, I wonder if they will be able to let decentralized decisions make and break their living conditions. Markets bring wonderful things in an economy (technological improvements, more and better products, more "freedom") but they can also be a destructive force (lost of employment, social frictions, bad distribution, pollution)... I wonder if Chinese officials are ready to let chaos in their carefully constructed castle of cards...

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