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October 21, 2008

Wall Street's Ripple Effect in China

Wei Jiang
Sidney Taurel Associate Professor of Finance and Economics
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How does the financial crisis affect business in China?

There are two ways: through the trading route and through the asset route. If the US economy goes into a recession and reduces demand from abroad, China will have to cut its exports, causing it to be affected as well.

I think that effect will be estimate-able because we have had, as recently as 9/11 when the stock market and NASDAQ dropped by more than 50% and the overall market dropped by a third, a real recession. China’s growth rate had a very limited drop from 2000 to 2001 because its components are income-driven and driven by internal demand. Thus, when the US economy took a huge hit, China wasn’t greatly impacted. Their domestic growth is increasing faster than the overall economy and that is increasingly more important as a growth-driver.

Secondly, the types of commodities and products that China exports to the U.S. is not super-sensitive to the economic downturn. For example, Wal-Mart accounts for 12% of total imports from China — if Wal-Mart was a country it would be China’s eighth largest trading partner — to just give you a sense of what these exports are. They are not super-sensitive to economic downturns.

What is new this time is the asset market. In the center of Shanghai there is a block of very expensive real estate. Morgan Stanley invested early on and made a handsome profit on paper. But only recently have they decided to sell. So you can tell it’s part of the deleveraging process where they are selling assets in order to raise cash to reduce the debt burden on their balance sheet. They have to sell in overseas markets because they couldn’t sell their subprime assets after market liquidity completely dried up.

Now they are looking at their balance sheet, and suddenly those assets they hold in China become their most sellable assets. Because foreign investments in China are real [estate] assets and are relatively new phenomena, China doesn’t have any experience with the contagions of financial crisis through the asset sales channel. That is what is new and we will have to see what effect that will have.

Photo credit: Aapo Haapanen

Comments

by Marshall Lee | October 22, 2008 at 12:45 AM

Professor, Isn't there a difference between stock market downturns and economic downturns? Back in 2001, the shock of 911 and the stock market drop were somewhat ameliorated by booming housing prices and consumptions didn't drop much. This time around, the credit market crunch seems to exert much bigger pressure on the US domestic consumption. I feel the impact should be larger. Marshall

by Kenneth Pires | January 27, 2009 at 3:30 PM

Professor, Very interesting insight and in hindsight we (the USA) are indeed in a recession and it is trickling up and down to other economies. While China may not experience a recession, they have and will continue to have smaller growth of their economy. Capital markets have continued to dry up and so far only government intervention appears to be large enough to make a difference in the near future. Even real estate assets in China will fall in value as less capital is available to buy it. Thank you.

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