Chinese Market Stability In Question

Investors React to Chinese Economic Data

There were recently major selloffs in all the major markets around the world when it was reported that China’s economy was growing at a hyper rate of over 11% rather than the hyper rate of just over 10% as expected. This leads to fears of Chinese interest rate hikes.

Now, if you recall, the last major selloff that happened a couple months ago was triggered because people feared that the Chinese economy was slowing down. Now, only a short time later, they’re selling off because it’s going too fast.

Investors are fickle.

The blessing in this of course is that the government can generally control a hot economy by raising interest rates, but they know that if it slows too much they can always lower rates again. As long as there is a demand (and there is no shortage of demand in China), they can manage the growth using interest rates and such. It would be a worse problem if there was not enough demand and they were trying to get the economy going … you can only lower rates so far before it creates other problems.

Warning: Automobile Analogy Ahead!

Imagine it this way. The economy is a vehicle. If there is lots of demand for products & services in the economy, it’s like having a powerful engine in your vehicle. The gas pedal represents interest rates; lowering the gas pedal is like lowering interest rates, raising the gas pedal is like raising interest rates. To make the vehicle (economy) go fast, you lower the pedal (interest rates) … but you can only make it go as fast as your engine (demand) dictates. You can make it go slower than the engine (demand) dictates, but you can’t make it go faster.

The opposite scenario is also true. If your car only has a little engine (low demand), you can lower that gas pedal (interest rates) as far as you want, but the vehicle (economy) isn’t going to get going fast for quite a while. China is NOT in this situation.

They have the largest vehicle (economy) and most powerful engine (demand) in the world. The fear is that their vehicle is going too fast and they need to raise the gas pedal (interest rates) to slow it down to a manageable speed … still faster than any other car on the race track.

So you see, having a vehicle (economy) traveling at a high speed (inflation) gives you the option of raising the gas pedal (interest rates) to slow it down; knowing that if you want to speed up later, your powerful engine (demand) will respond if you lower the pedal (interest rates) again.

By the way, there is another item that can slow the vehicle down … a low supply of gas (supply … commodities, goods & services). The gas is what the rest of the world is scrambling to supply to China … everything from technology & commodities, to machinery & expertise.

Okay, let’s keep going with this scenario …

The reason that the markets in the rest of the world react negatively when China raises the gas pedal (interest rates) in an attempt to slow their vehicle (economy) down to a more manageable speed (inflation), is because China’s vehicle (economy) won’t need as much gas (supply) if it isn’t traveling as fast.

Rest assured, there is still a lot of power in that engine (demand) and raising the gas pedal (interest rates) simply means that they will be able to race ahead for a longer period of time (better gas mileage) .

Thanks to Dan for the Analogy

Leave a Reply

Your email address will not be published. Required fields are marked *