China: more important than Greece

While most of the world was overly focused on Greece, bigger things were afoot in China.

First, the Chinese economy is the 2nd largest in the world. What happens in China matters for the world economy. In contrast, Greece's economy is but 2% of the European economy. Although Greece's problems are likely to become broader problems in Portugal, Spain, Italy and France, by itself Greece doesn't have a big impact on the world economy.

Second, China's economy is still essentially run by a communist central planning authority. They are giving some free market principles a try, but they have maintained a firm grip on the most important things. How they react to the inevitable ups and downs any economy faces is important for understanding how the world economy will do in coming years and decades.

Over the last year, the Chinese government has been showing they aren't ready for prime time. First, they have reacted to economic slowing--inevitable in any economic system, whether capitalistic, communistic, socialistic, etc.--with attempts to prop things up. As usual, such attempts look good in the short term but fail over time. Governments just aren't any good at allocating capital.

Second, they are misreading market reactions and have basically lost their cool. After trying to use free markets to boost their economy, they are now trying to prevent markets from clearing by forcing large stockholders to hold instead of selling. There is nothing that spooks markets more than a government's attempts to force the outcome they want instead of the natural equilibrium that would otherwise exist.

This a classic reversal of cause and effect. Stock markets, like all markets, react to news by adjusting prices to make supply and demand match at market clearing prices. Any attempt to prevent that mechanism from operating in the short term leads to disastrous effects in the long run. Markets are effects, not causes, contrary to how many politicians and historians like to interpret the facts.

The more the Chinese government continues to overreact and try controlling outcomes, the more world markets will overreact as a result. Such impacts will be much worse than letting markets find equilibrium. Just witness commodity price swings in reaction to Chinese intervention and you can get a flavor for how nasty things can get. 

I think what is going on in China should be watched much more closely than what is happening in Greece. The stakes and consequences are much greater.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.