Beijing targeted as investors look for a scapegoat

Why China's market meltdown affects the rest of the world
Why China's market meltdown affects the rest of the world

Beijing has been blamed squarely for this week's wild ride on global markets. Analysts are worried by turmoil in China's stock markets, and signs that the country's massive economy is flagging.

Some critics have gone even further, insinuating that Beijing has misled the world about the severity of its economic slowdown.

It seems China can do nothing right. In recent days, Beijing has been criticized for allowing a stock market bubble to form, criticized for intervening when markets fell, and criticized yet again for pulling its support and allowing stocks to resume their decline.

The charges come just three weeks after China allowed its currency to slide against the U.S. dollar, which prompted howls of outrage in U.S. political circles. Beijing was criticized for "manipulating" the yuan, rigging the market in its favor.

But Beijing has a right to feel unfairly targeted. It is, in fact, doing what Western policymakers and institutions have long called for: developing an economic model driven by consumers, and letting the market decide, at least to a degree, what its exchange rate should be.

Starting in the early 1980's, China produced 30 years of lung-busting growth that frequently topped 10%. To pull off this "economic miracle," Beijing relied on a growth model based on producing cheap gadgets and selling them to the world. The income from those exports were plowed into the greatest infrastructure boom the world has seen.

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Policymakers understood the good times couldn't last, and in recent years, started building a new economic model where the consumer will be king, and consumption will be main driver of growth. The model will produce growth at a lower level, perhaps 6% to 7%, but it will be more sustainable. Beijing has repeatedly made it clear that this is the "new normal."

The execution of the plan has been difficult, and filled with missteps and reversals. But it's worth noting one important development: the consumer is showing signs of life.

The prime catalyst for this week's global stocks tailspin was manufacturing data that showed factory output in China had slumped to a 77-month low. It's a scary figure, but less so in the context of an economy moving towards consumer demand. The actual consumer services index in China is at an 11-month high, according to Capital Economics.

Capital Economics is not alone in calling for calm about the state of China's economy. Heavyweights HSBC thought the headlines about the state of the Chinese economy were a little "sensational" for its tastes.

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It's also important to note that unlike most mature stock markets around the world, the Shanghai Composite has only a tenuous relationship with the real economy.

Yes, it's having a very rough few months, but here's some context: The sharp recent losses follow a long bull run. The Shanghai Composite is still up roughly 35% from this time last year, while Shenzhen is hanging on to a 45% gain. Foreigners own only 1.5% of the market, and most of China's vast savings are held in property and cash.

Chinese stocks, in other words, are a sideshow compared to the country's economy.

And there, Beijing still has plenty of measures it can use to support growth.

"China's policymakers still have sufficient policy ammunition on both the monetary as well as fiscal fronts," said economists at HSBC, who forecast a modest economic recovery in the second half of the year, leading to 7.1% growth for 2015.

It's also clear that China cannot support global growth the way it did during the 2008 global financial crisis. As the rest of the world virtually froze, China kept turning, helped by a massive $600 billion stimulus package. It shouldered global growth pretty much on its own. But right now, as its painful economic transition continues, it can't anymore.

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