Tumbling Stock Markets

August 31, 2015
Editor(s): Naren Rajan
Writer(s): Sugiharto Tunggal, Stefanny Sugianto, Mayumi Edirishinghe, Lim Cheong Toh

Global market crashes have always been a serious issue for investors because of their potential to cause havoc and financial distress all around the world. Recently, the global stock market has been in turmoil due to the recent plummet in the Chinese stock market. The British stock market was heavily hit which caused 162 billion USD to be wiped off from the market overnight. Australia also experienced a similar situation, where 64 billion USD is torched from the market.

Many analysts have commented on this event, one of them stated that this could be an ‘early stage of a very serious situation’ (Lawrence H Summers, 25 Aug 2015). This article is going to discuss the main causes of China’s stock crash and its effect to global market according to many analysts. In particular, it will focus mainly on its effect on the Australian stock exchange and economy which has experienced a weaker exchange rate recently.

Over the last 12 months till mid-June, China’s stocks soared by 150%, as millions of ordinary citizens started investing in the stock market with borrowed money, creating a bubble. Concerned that the stocks are overvalued, earlier this year the Chinese authorities tightened the monetary policy to limit these debt-financed stocks. The country’s declining GDP growth rate and the recent yuan devaluation, in its attempt to move from an export-oriented economy to a more sustainable economy dependent on domestic consumption, further affected investors’ confidence which led to the 8.5% fall in the Shanghai Composite index on 23rd June 2015, regardless of the drastic measures taken by the authorities to contain the sell-offs. According to the economists, this is the worst single-day decline since the GFC. This has sparked global stock selloffs triggering huge losses in the Asian, European, and US stock exchanges, which plummeted at the closing of Monday. Furthermore, this declining demand in the world’s largest importer of raw materials caused the price of commodities such as copper, iron ore and crude oil to tumble.  Beyond these losses, emerging-market currencies have also weakened while safe investments such as the US and German government bonds, gold and currencies like the Yen and Swiss franc have increased in demand. While some analysts say that this panic is merely an overreaction, considering that China is the world’s second biggest economy, it is possible that this turmoil will lead to another major global economic crisis. Without a doubt this crash could have ramifications, particularly for countries that export to China.

There are various reasons for the share price plummet. The emergence of small-time traders with no proper financial knowledge is one of them; with nearly two third out of five million owners of trading accounts opened on March did not complete high school. This factor might provide an explanation to the irrational increase in value of smaller companies. The stock bubble was created due to the excessive amount of money injected into the market by the average citizens. Furthermore, the controlling actions by the Chinese government did not function as expected. The interest rates cut, suspension of new IPOs and stock buy backs did not convince the investors out of the negative perceptions.

What does this mean for the Australian economy? There is no doubt that there is no more urgent issue to Australian economy than the transition from the end of the mining boom. Construction and capital expenditure data released this week shows that the mining boom has hit its peak and is reversing. The very force that has pushed Australian economy to prosperity will start pushing Australia down to stagnancy and probably to bust as history repeats itself. As its primary source of income comes crumbling, we can prepare ourselves for an unprecedentedly high unemployment and economic downturn. However, the depreciation of Australian currency to its lowest level since mid-2009 has shed some light to Australian economy. Although the plunge of Australian dollar has drained more than $60 billion in Australian markets on last Monday alone, it will undoubtedly help non-mining industries in Australia to improve. Prior to this crash, it has also been suggested that non-mining sectors have been struggling. Consequently, the lower dollar will certainly able to smooth Australia’s much needed transition in these sectors. It will make Australian exports cheaper in terms of foreign currency, making them attractive to foreigners. This will almost certainly induce higher demand of Australian exported products, increasing Australian net exports. With stronger exporting sectors in Australia, Australia will thus enjoy smoother transition from the end of mining boom as other industries can prosper and take over the baton.

The fundamental building block of stocks market is a financial instrument platform that represents the public listed companies’ earnings and assets. The overall health of the companies is shown in the stock market and provides performance indicators for the industries and the overall economy. The abrupt plummet of the China’s stock market has indeed created a short-term chaotic situation for the Chinese investors and the international market players. Nevertheless, a closer look at the correlation between the stock market and the economy, the impact has not actually affected the Australian economy as of yet. Comparatively, the Chinese economy has been slowing down since the 2008 global financial crisis, where the growth has slowed to 7.4% on 2014, and is expected to drop further to 6.8% this year while the Chinese stock market was also said to be overvalued before it fell.

References:

Allen, K. (2015, August 25). Why is China’s stock market falling and how it might affect the global economy? Retrieved August 27, 2015 from www.theguardian.com/business/2015/aug/24/china-stock-market-fall-effects-global-economy-shares-interest-rates-inflation

Janda, M. (2015, August 25). Australian shares fall 4pc wiping $64b from market value; Chinese shares plunge on ‘Black Monday’. Retrieved August 27, 2015 from www.abc.net.au/news/2015-08-24/australian-shares-fall-4pc-wiping-64-billion-from-market/6721044

Joyner, A. (2015, August 25). China stock market crash explained in 90 seconds. Retrieved August 27, 2015, from http://www.ibtimes.co.uk/china-stock-market-crash-explained-90-seconds-1516957

Lee, T. (2015, August 25). The global stock market crash, explained. Retrieved August 27, 2015, from http://www.vox.com/2015/8/25/9205663/stock-market-crash-explained

Lee, T. (2015, August 26). China’s stock market falls for the 5th straight day. Retrieved August 27, 2015, from http://www.vox.com/2015/8/23/9195891/china-stock-market-crash

The causes and consequences of China’s market crash. (2015, August 24). Retrieved August 27, 2015, from http://www.economist.com/news/business-and-finance/21662092-china-sneezing-rest-world-rightly-nervous-causes-and-consequences-chinas

The Economist. (2015, April 14th). Free Exchange Economist. Retrieved August 26, 2015, from Economist: http://www.economist.com/blogs/freeexchange/2015/04/china-booming-stockmarket

The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.

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Naren Rajan
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Sugiharto Tunggal
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Stefanny Sugianto
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Mayumi Edirishinghe
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Lim Cheong Toh
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