Here’s Why China's Stock Market Sunk

January 11, 2016

China's stock market is free-falling again. Much like they did during the summer of 2015, Chinese stocks are dropping precipitously, reigniting worries about the health of the world's second-largest economy.

On two separate occasions this week, the market fell by 7%, prompting newly instituted circuit breakers to halt trading for the day.

On Thursday, authorities suspended those circuit breakers after conceding that they may be doing more harm than good by driving investors into a panic. The flip-flop only added to the sentiment that the Chinese government doesn't know what it is doing.

China Devalues Its Currency

Compounding the recent China jitters has been the surprisingly swift decline in the country's currency. The yuan sagged to a five-year low against the U.S. dollar last week, and analysts say more losses could be in store.

Of course, if the market were left to its own devices, the yuan would almost certainly be down even more. The People's Bank of China maintained the currency at an artificially high level for much of last year, burning through hundreds of billions of dollars of foreign exchange reserves to do so.

Only in August of last year did the PBoC finally move to weaken the yuan, but only gradually. As investors rush for the exits, the central bank continues to use its multitrillion-dollar foreign exchange stockpile to manage the decline in the currency.

According to government figures, China's foreign exchange reserves dropped $513 billion to $3.33 trillion last year, with $108 billion of that coming just in December.

Experts Respond

With that context in mind, sat down with two experts to get their take on the latest events in China. We asked them about three key areas as they relate to China: the stock market, the currency and the economy.

ETF: What are your thoughts on the fall in China's stock market; is it destined to fall further, and is the government's constant intervention helping or hurting?

Brian Jacobsen, chief portfolio strategist, Wells Fargo Funds Management: China has a communication problem more than an economic problem. Every depreciation of its currency is viewed as an act of desperation to prop up exports.

But in fact, it’s the natural consequence of letting the [yuan] float. Back in April, I thought it was 10% overvalued. We’re past the halfway point in terms of getting closer to fair value, so maybe the worst is behind us.

The intervention in the stock market is a form of interference. Now they have to intervene to get rid of the interference. The alternative is to abruptly let things settle where they should, but the risk is that things will get materially worse before they get better.

That’s why the recent moves to eliminate the trading circuit breakers and modify the restrictions on major shareholders from selling are half-baked, but better than doing nothing.

(Check out our Definitive China ETF Guide 2015)

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