Opinion: Lessons for China From the Global Stock Rout

Global stock markets have experienced notable fluctuations recently, followed by a significant decline in U.S. stocks at the end of July and early August. The VIX index, often referred to as the "fear index," reached its highest level since the start of the COVID-19 pandemic in March 2020. On August 5, a wave of panic caused considerable disruption across global stock markets, most notably in Japan and South Korea. The Nikkei 225 index in Japan fell by 12.4%, marking its largest drop since 1987, nearly wiping out the gains made earlier in the year over three consecutive trading days. Similarly, South Korea's composite index closed down by 8.77%, with an intraday drop exceeding 10%. European markets and other regions also saw significant declines. Although China’s A-share market suffered less, it still fell by 1.54% with the Shanghai Composite Index dropping on that particular day. Eventually, markets in the U.S. and Japan rebounded [para. 1].

This market turmoil is indicative of more than just capital flow; it reflects current economic sentiments and future economic projections. It should be considered a subject for serious contemplation rather than an irrational episode [para. 2]. Factors contributing to the turmoil included underwhelming U.S. GDP growth and non-farm payroll data for the second quarter, and lackluster performance from tech giants, which failed to support high valuations. Additionally, investors began reversing the "carry trade" due to expected U.S. interest rate cuts and Japanese rate hikes [para. 3]. These events underscore that financial markets are barometers of economic health. Despite global economic decoupling, capital flow persists, showing interconnected financial markets. For China, aspiring to be a financial powerhouse, grasping the role of finance is crucial [para. 4].

There is a debate on whether the U.S. economy is heading toward a recession. While some predict a downturn and even a mild recession, others believe in the resilience of the U.S. job market. Regardless, capital movement suggests a bearish outlook and strong risk aversion, highlighting the intimate link between the capital market and the economy. Financial turmoil often precedes economic turning points, and addressing market issues through secondary interventions may backfire even with significant resource deployment [para. 5].

Finance is central to the modern economy. A thriving financial sector translates to a thriving economy, with stability in finance reflecting economic stability. Governments should respect financial laws and regulate finance to maintain the sector's vitality. Managing market expectations is also essential, as unchecked market panic can harm the real economy despite no fundamental changes in economic conditions. This has led regulators to focus on expectation management, though there is still room for improvement [para. 6].

The ties between Chinese and U.S. capital markets aren't as robust as those between the U.S. and Japan, but the U.S. economic and financial conditions significantly impact Chinese markets. U.S. interest rate hikes usually cause capital outflows from China, yuan depreciation, and pressure on Chinese stocks. Conversely, rate cuts result in increased foreign capital inflows. Since China is a major exporter, a U.S. recession would negatively impact Chinese exports, correlating U.S. stock market declines with Chinese mainland stocks dipping as well [para. 7].

Stock market fluctuations reflect market value discovery and should not impede China’s financial openness. The recent Third Plenary Session of the 20th Central Committee of the Chinese Communist Party emphasized advancing financial openness and the internationalization of the yuan. Measures to support this include aligning with high-standard international economic and trade rules and improving cross-border investment and financing ease [para. 8]. Despite embracing openness, it is crucial to mitigate financial risks. While the 2008 financial crisis saw coordinated global policy responses preventing an economic catastrophe, today's anti-globalization and geopolitical factors make international policy coordination more challenging. Hence, China needs mechanisms to mitigate risks through systemic reforms and market development [para. 9].

Each international market shock is a moment for introspection. China's sustained economic prosperity and vibrant financial markets depend on deeper global integration. Balancing the benefits and risks of openness requires courage, robust firewalls, and continuous regulatory enhancements [para. 10].