Tag Archives: People’s Bank of China

China: economy and finances are still very connected

The Chinese economy is living an unstable situation after decades of continuous strong growth, with some years over 10%. Suddenly, there was an earthquake in August. Since then, the Chinese economy slowed its momentum depending on the world. This time all moved at the Chinese speed. The unexpected decision of the People’s Bank of China of devaluating the yuan three times in August was a shock in the world markets, as in the developed ones as in the emerging ones.

Evolution YTD of stock exchanges in China and others

The consequences were so strong, as we already explained in a former post, that the US Federal Reserve delayed its decision of hiking the interest rates due to the financial instability. What was at the beginning the end of the Chinese stock exchange bubble, it is now the start of a possible economic crisis: several figures are warning about the evolution of the second largest world economy. For instance, exports and imports go down, the inflation moderates and industrial prices slow down, the World Bank prospects for the next years speak about a deceleration (around 7% of GDP growth, when the figures were over 9%-10% in the last decade). As The Economist comments, China is a giant in trade and direct investment, but in finances and financial markets is still weak.  There is still a long pace till China will play a stronger role to substitute US as the first player. The immaturity of its financial markets is clearly showed in this chart:

Shanghai composite evolution in the last 5 years

This is the evolution of the Shanghai composite in the last 5 years. The evolution was weak between 2011 and 2013 linked to the global crisis, but suddenly a bubble was created this year and exploded violently. Chinese authorities reacted late and could not control the hard effects. The YTD gains around 40% till August are now around 1.8% (it was negative till the last week). The volatility is very high (38%) and trend is very bearish (-1.87%), as T-Advisor models show. However, investors who entered this market in October last year have registered 40% benefits.

What are the results of ETF linked to China? T-Advisor database show global negative results YTD, but most of them are improving its results in the last month:

Results of ETF in China

And the final question is: what will it happen in China? We have models, figures and charts, but no crystal ball, but we can say that it will depend on the evolution of the economy. It is still very linked to financial markets and the decisions of the government. In any case, let’s say welcome to China as very influential player in the world markets.

Why central banks are relevant for you, investor?

When you read the newspaper, you find always news about the Fed, the ECB, the BoE or the BoJ. These are the initials of the most important central banks: the Federal Reserve in US, the European Central Bank for the euro-countries, the Bank of England in Great Britain and the Bank of Japan. This year, another bank has emerged because of the influence of its decisions in the global economy: the People’s Bank of China.

What are these banks? They are not commercial banks, but they have relevant tasks for the economies. The origin of each is different: for instance, the Fed was created before de WWI after a deep banking crisis; the ECB is the result of an agreement amongst the countries which use the euro as a currency…

What are the main tasks? Well, central banks have the monopoly of printing money. Due to this responsibility, they control the monetary policy through the main instrument: the interest rate. This regulates the amount of money in the system. They are also lenders of last resort for commercial banks. Of course, the tasks can be wider depending the country. For instance, if the currency is pegged to another, they decide also the exchange rate.

Why do they have such influence? Governments delegate the monetary policy in these institutions. They usually have the mandate of controlling the inflation. This is the main role for the ECB in Europe. The mandate of the Fed, on the contrary, is double, because it has to take into account not only the inflation, but also the economic growth. Decisions have to be taken in order to achieve both.

As an investor, why are they relevant for me? You surely have heard the news in August about the drop of the stock exchanges. The origin was in the sudden decisions of the People’s Bank of China, which devaluated the yuan three times in three days. The worldwide effects can be perceived in this chart:

T-Advisor chart with the impact of the devaluation of the yuan in the stock exchanges last August

This is not the only example. The exchanges follow continuously the steps of these banks, as the interest rate has a relevant influence in the evolution of the economy or the companies. For instance, it is expected that the Fed tightens this year its monetary policy increasing the interest rate. The debate has been continuous since the last year and keeps on. As a result, the S&P was quite unstable in the last 12 months. It is relevant the drop before Christmas, when the Fed met for last time in 2014:

S&P evolution in the last year

The relevance of the Fed is also huge in the commodity markets, as they are nominated in dollars. In the case of the ECB, it has built an own vocabulary. It was famous with the former president Jean-Claude Trichet that the increase of the rates was announced two months before saying that the institution was “vigilant” with the price evolution and a month before saying “very vigilant”. The bank prefers to be foreseeable in order to avoid sudden market movements. Current chairman Mario Draghi was also famous, because his words defending the euro stopped the instability over this currency in 2012.

In any case, you, as an investor, should watch what the central banks say. If you are a trader, follow every word. If you are a long-term investor, take care of the statements to rebalance your portfolio in certain moments.