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Evan Horowitz | Quick Study

Why are the markets falling? Troubles in China

Stock markets are falling fast. After a dismal performance last week, the Standard & Poor’s 500 is struggling to climb back from a sharp early Monday drop, while markets all around the world have endured big losses.

What’s shaking investor confidence? In a word, China, where weak economic numbers and some increasingly desperate interventions by the state have awakened investors to the possibility of a painful slowdown.

Add in concerns about how malaise in China could hurt other developing countries, plus fears that the Federal Reserve Board of Governors has lost its patience for necessary stimulus, and you have all the ingredients for a global sell-off.


What’s happening in China?

For decades now, economic growth in China has been fiery, often reaching rates above 10 percent.

But those heady days of consistent, high-octane growth seem to be over. In the first half of 2015, China’s growth rate was 7 percent, and that’s if you believe the official numbers (for comparison, a recent independent analysis found that the true unemployment rate in China may be nearly three times the official rate).

Fears were stoked earlier this month when China removed some of the limits on currency trading and the value of the yuan fell substantially. Even though the Chinese government was probably hoping for the yuan to lose some value, investors interpreted the drop as a sign of weakness.

That’s because China was supposed to be moving past the export-first phase of its development — no longer just a place for companies to make cheap products, but a mature consumer market where companies from around the world can sell their goods to the growing Chinese middle class.

Also disconcerting was the way the Chinese government handled its July stock market collapse, where it intervened aggressively to prop up stock prices, suggesting that it isn’t ready to let markets operate on their own.


Why would this affect stock prices?

It’s important not to exaggerate the connection between market fluctuations and events around the world. There’s a lot of unpredictability in market movements, and it’s often impossible to tease out the deeper forces driving markets.

But here’s how the slowdown in China might be feeding the current troubles.

The most basic reason stock prices fall is because investors start to think — or fear — that companies are going to perform worse than previously anticipated. And if China is facing a severe economic slowdown — one that could hamper the development of a robust Chinese consumer class — some companies would indeed have a smaller market for their goods. That means lower profits, less money to share with investors, and lower stock prices.

Are there other factors?

China is far from the only thing weighing down markets. Other concerns include:

■  Contagion: If China’s economy really is slowing, lots of other countries will suffer alongside. As an example, a slowing China would probably need less oil, driving down oil prices and hurting oil-dependent economies like Russia, Venezuela, and Saudi Arabia.

■  Rising interest rates: For months the Federal Reserve has been preparing investors for a hike in interest rates. But the point of raising rates is to keep the US economy from overheating. And with China’s slowdown threatening the US economy, the big challenge may be to heat the economy back up, not cool it down.

■  An overdue correction: The stock market has been outperforming the US economy ever since the Great Recession. There’s some good reason for that, including the fact that corporate profits have been particularly strong. But the market can only run so far ahead of the real economy before some kind of correction sets in. And that may be what we’re seeing now.


What happens next?

Sometimes a sharp downturn in the markets is followed by an equally sharp recovery. Other times, there’s no such rapid rebound. After the black Monday sell-off in 1987, it took more than a year for the S&P 500 to recoup its losses. After the tech bubble burst in 2000, it took about six years.

One hopeful precedent is the 1997 Asian financial crisis, which swept through much of southeast Asia and initially sent the US stock market tumbling. Within a few months, all those losses had been recouped.

Then again, in 1997 China was largely insulated from Asia’s economic troubles. That’s not true this time around, and it could mean a wider fallout, a slower recovery, and possibly some spillover from a stock market crisis into a full-on economic downturn.

Evan Horowitz digs through data to find information that illuminates the policy issues facing Massachusetts and the United States. He can be reached at evan.horowitz@globe.com. Follow him on Twitter @GlobeHorowitz.