The Chinese stock market fell dramatically last week. That sounds significant but it actually isn’t. First, the Chinese stock market doesn’t serve the same function as Western markets. The equities that are sold there do not allow shareholders to control companies, nor are the underlying values of these companies correlated to the price of the stocks in any way. Second, the percentage of China’s wealth that flows through the markets is relatively small compared to the size of China’s economy. Market capitalization has little to do with value of Chinese companies.
The really significant news last week related to China’s foreign reserves. The People’s Bank of China revealed on Jan. 7 that the country ended 2015 with less foreign reserves than it started the year with. It was the first time reserves shrank over the course of a year since 1992. In effect, China saw its first decline in reserves since the Chinese boom really got under way. The surprising part of this development is not the contraction, since that’s been going on for at least a year, but the fact that it was announced. And this announcement told us that China entered a new era in 2015 and is now in uncharted waters.
There are more important implications stemming from the decline in reserves than the Chinese stock market’s panic. The government’s anxiety was shown by aggressive assertions of confidence, demands for greater discipline, and an intensification of arrests of Chinese officials, businessmen, and others. The government is worried and is clamping down. Indeed, it has been worried for several years, and President Xi Jinping has been trying to maintain social stability in the face of a sea change in China’s economy. Now, as he attempts to reform—and control—the People’s Liberation Army, which is the key to China’s regime, we are in the witching hour in China. Whether the regime can maintain stability in the country while it undergoes managed change is at issue.
I wrote last week about China’s reality and strategy in anticipation of this sort of crisis. The task this week is to step back and take a look at the global reality. China is not the only nation in Eurasia facing social and political instability as a result of economic shifts. Almost all of Asia, with the major exception of India, is undergoing growing instability of different sorts. The Europeans are struggling to deal with massive economic and political divergences within the European Union. The Russians are simultaneously attempting to deal with an economic crisis stemming from declining oil prices, but rooted in their inability to use oil revenues to build a more robust economy. The Middle East is in political and military chaos, due to reasons ranging from US attempts at disengaging from the region to deep animosity between Shiite and Sunni Muslims. And Central Asian countries, caught between Russian and Chinese dysfunction and the lapping waters of M uslim discontent, are struggling to contain the resulting unrest.
What we are seeing is a region—from the Atlantic to the Pacific, and from the Arctic to the Indian Oceans—destabilizing. Of the 7 billion souls alive today, 5 billion live in this region. In most of Eurasia, the realities that have been taken for granted for the past generation are no longer certain. There has been a belief in much of the region that, at some point, everything will go back to normal. It was assumed that China’s economy would flourish; that Europe would sort out its problems; that, without the US presence, conflicts in the Middle East would subside; and that Russia would, in due course, accommodate itself to its new liberal democratic principles. However, none of those things are going to happen. Instability, uncertainty, and increasingly impotent regimes trying to find their way out of the crises they have stumbled into, are the new normal.
The different parts of Eurasia will not experience the same type of crisis. China’s problems are not the Middle East’s, and the Middle East’s are not Europe’s, but these regional crises have a common cause and interact with each other, complicating them enormously. I wrote a recent article for Mauldin Economics about an emerging crisis for major exporting countries. I want to expand on this in order that we might understand the root cause of the Eurasian crisis—interdependence. Interdependence has been seen as a panacea for humanity’s problems. However, it solves problems, but also creates them. Its most important weakness is that a systemic failure in one region rapidly spreads to other regions. The attempts to solve problems in some nations also affect other countries. Therefore, a byproduct of an interdependent system actually turns into the most dangerous reality of all. This byproduct is conflict among nations, as they str uggle to stabilize their own crises and are constrained by the behavior of other countries. The conflicts brought on by interdependence are the most dangerous because they breed the greatest desperation.
The current Eurasian crisis began in 2008, a crisis that resulted in recessions that had a global impact. The United States and Europe reduced the amount they imported from around the world. China was in a particularly vulnerable position because its economy was heavily dependent on exports. It had been expanding dramatically for over a generation and, as ought to have been obvious, such an expansion was not eternally sustainable. By 2008, China was reaching the limits of its economic model. But as many do, China sought to extend the model, not so much out of greed, as out of fear of what slow growth might mean socially, in an extremely poor country. The Chinese sought to sustain the economy through various forms of subsidies that continued to support growth in GDP—although not at the same level as before—but pyramided the growing irrationalities of the economy. It was cushioned by its financial reserves, but that could last only so long.