Latest Tariff Problem, China Markets Take Pounding

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The bears have officially taken over China’s Shanghai Stock Exchange. The exchange’s composite index fell to 20.1% below a high posted in late January. Shanghai now joins Shenzen’s Senex exchange, which has been in bear territory since February.

The Shanghai bear market is just one symptom of a bigger problem for the world’s second-largest economy. Economic growth is stalling as the country tries to reduce its debt load, and government efforts to jump-start growth are not having the desired effect.

The yuan, which started the year strongly, has declined versus the dollar and appears headed for its longest losing streak in years. Toss in the known and as yet unknown impacts of a trade war with the United States, and it is not difficult to find reasons for China’s slump.

The government has tried to address the country’s massive debt burden by restricting capital flows. But those restrictions also limit the government’s willingness to provide near-term liquidity, and that constrains the flow of foreign capital into the country.

A good example is the proposed IPO of smartphone and consumer electronics product maker Xiaomi. The company’s plan to issue depositary receipts in Shanghai along with ordinary shares in Hong Kong ran into regulatory issues. Had the IPO gone ahead as planned, mainland Chinese investors who are prohibited from sending investments out of the country would have been able to buy a new class of security, Chinese depositary receipts (CDRs), adding liquidity to the home markets.

And even though the Chinese economy is so vast, there is some doubt that it could withstand a full-fledged, take-no-prisoners trade war with the United States. That makes investors nervous, and nervous investors sell equities and pile up cash. Whether or not a weaker Chinese economy represents a victory for Trump and his “easy to win” trade war remains arguable.