24/7 Wall St.

There is a fairly widely held theory that moves in the stock market are a good predictor of what will happen in the broader economy two quarters later.

The Shanghai Composite, the largest measure of Chinese stock prices has dropped by over half since its October high of over 6,000. As The Wall Street Journal points out "It is crimping expansion in the country’s nascent financial sector and may put a squeeze in corporate coffers."

The drop in the index is signaling something much worse than a dip in the IPO market. The Chinese economy is facing serious problems and they cannot be fixed by the central government. Their magnitudes are too great.

Inflation in China is said to be 8%. That number is laughable. Food prices are moving up closer to 20%. If the Chinese government did not subsidize the price of gas and diesel, the cost of these would probably have gone up by at least 50% this year. China’s big oil companies buy crude on the world market, often for amounts over $100. Gasoline prices in the country are among the lowest in the world. China needs to keeps cars and trucks on the road to keeps its economy humming. The artificial dementing of fuel supply and demand cannot last forever

The larger issue in China, one that it leaders are beginning to acknowledge, is that the slowing economy in the West is going to hurt the country’s GDP growth, perhaps badly. The recession in the US and Europe could get worse. The demand for Chinese goods could fall off a cliff.

China is moving toward a recession of its own. The drop in the Shanghai Composite is just one sign.

Douglas A. McIntyre