Doing The Shanghai Shuffle

The swoon in stocks won't slow down the Chinese growth machine

The brokerages in Shanghai were packed to the gills on Feb. 27, as anxious small-time investors gathered in tense silence to watch their holdings dwindle.

But the rest of China—the China that makes shirts, assembles electronics, manufactures cars, and forges steel—barely noticed. China's growth remains intact, and the swoon in the Shanghai bourse will do little to slow it down.

How so? For starters, China's shareholder class, though expanding rapidly, is relatively small, so a wipeout in stocks won't affect broad trends like consumer spending and investments in factories. Most Chinese have their savings stashed in bank deposits rather than stocks: Only 9% of household assets are in stocks. So the market turmoil will have little impact on China's $2.7 trillion economy. The country is still on track to post 9.1% in 2007, and likely will soon overtake Germany as the world's third-biggest economy. China is not going to take the world economy down with it, at least not this time. The effect of the Feb. 27 plunge "on global growth is approximately zero," Standard Chartered Bank senior economist Stephen Greene wrote in a note to clients.

China still has plenty going for it. Wages have risen enough to give a projected 8% boost in consumption this year. Yet the economy remains competitive, with labor costs still a fraction of those in the West. Beijing is booming as the capital revs up for the 2008 Summer Olympics. Chinese corporations are reporting profit gains of 40% on average. Some sectors are winning some pricing power: In late January, Baoshan Iron & Steel Co. forecast a hefty rise in steel production in 2007 and raised prices by about 5% on strong demand. Finally, the government is spending to boost incomes and living standards in the country's interior.

Stock gyrations, however savage, have little impact on these trends. China's bourses, in fact, performed dismally until last year—with no visible effect on the country's growth. The losses of Feb. 27 in Shanghai don't hold a candle to the $230 billion trade surplus China will probably record in 2007.

The real danger to investors isn't a stock market crash but a Chinese economy that grows so fast the government has to intervene and slam on the brakes. That happened in the 1990s under the premiership of Zhu Rongji, who tamed inflation but slowed gross domestic product growth to a crawl. Indeed, one of the precipitating causes of the sell-off was the People's Bank of China's effort to drain liquidity from the economy by requiring banks to park more cash with the central bank. Monetary authorities are worried about the rapid expansion in consumer lending and other excesses.

So the PBOC may follow up with an interest rate hike soon. And the government may introduce capital-gains taxes on real estate transactions to curb bank lending. China still has plenty of risks. But don't look for the real trouble to erupt on the floor of the stock exchange.

By Brian Bremner

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