Black Monday for China’s stock markets

China’s stock markets fell the most since 2007 yesterday. China, Vietnam & Kazakhstan have already devalued their currencies. Will Thailand be next? Currency wars in Asia on the horizon?

ECONOMICS

Black Monday for China’s stock markets

Yesterday was Black Monday for China’s stock markets.

China’s richest man lost US$3.6 billion in a single day or 10% of his wealth on Monday.

China’s second richest person Jack Ma, founder of e-commerce giant Alibaba, lost only $545 million on Monday (read story here).

The expression “Black Monday” comes from the original “Black Tuesday” the Stock Market Crash of 1929 which happened on Tuesday, October 24, 1929, the most most severe stock market crash in US history which would eventually lead to the Great Depression of the 1930s.

But the collapse in China’s stock market yesterday didn’t happen overnight.

China’s economy has been sputtering with lower than expected growth for quite a while and events over the last two months set the stage for yesterday’s collapse in share prices.

To recap recent stock market history:

On June 12 the Chinese stock market reached a record high but by the end of July it had experienced its worst month since 2009 with the important stock price index, the Shanghai Composite Index (SCI) falling 15% during the month.

On August 10 China devalued its currency by almost 2% and stocks began falling. Investors worried “the change will cause more money to flow out of China, reducing credit available for trading.” (See here & here)

On August 24 or “Black Monday” China’s stock markets fell precipitously with the SCI falling 8.5%, the most since 2007.

CURRENCY WARS IN ASIA?

So far, the Asian countries China, Vietnam and Kazakhstan have devalued their currencies, a move aimed at making exports more competitive and according to William Pesek of Bloomberg, “analysts suspect Thailand will be next.”

To explain what devaluation of a currency means, take the Thai baht. Devaluation of the baht means the baht becomes weaker or less valuable compared to other currencies. For example, if the baht devalues from 34 baht to a US dollar to 35 baht to a US dollar, then US buyers of Thai export goods get more baht when they exchange their US dollars for baht, so they can buy more Thai goods with their dollars, which means Thai export goods become cheaper, more attractive and more “competitive” compared to the export goods of other countries in the market for exports.

However, devaluation is unlikely to be a successful strategy if every country is doing it and the global economy is weak without a lot of money available (purchasing power) to buy export goods.

There are, however, benefits to be gained by a country not devaluing their currency and instead living with a strong currency. A strong exchange rate (35 baht to a dollar rather than 32 to dollar, for example): 1. attracts long-term capital inflows because investors get more for their money, 2. makes imports (such as large amounts of natural gas for electricity in Thailand) cheaper which can reduce inflation, 3. reduces government debt burdens, 4. allows companies to borrow on international markets at lower rates which leads to investment which helps a country develop in the long-run. (See William Pesek’s Bloomberg column here).

In fact, devaluing a currency when a country has a lot of so-called “dollar-denominated debt” (loans in US dollars, for example) means it will cost more to pay back these loans (rising debt servicing costs). If China’s currency fell (devalued) too much, many more Chinese companies might not be able to make their loan payments and default on US dollar-denominated debt, which could really hurt the economy. Furthermore, Thailand’s ASEAN neighbours Indonesia and Malaysia have also “gorged on overseas loans in recent years. As of July, companies in those countries, together with their governments, had sold more foreign-currency debt this year than they did in all of 2014. That’s becoming a clear vulnerability with the ringgit and rupiah down 18 percent and 12 percent, respectively, this year.”

Taking all of the above into account, William Pesek finally concludes “Asia Should Call Truce on Currency War.”