Friday August 20, the DOW dropped by 530 points, ending the week with an over 1,000 drop. This past Monday saw yet another 588 dump, followed by 204 the day afterwards.
That’s about 1,800 points … an 11% drop in this stock market index in just the last week. Watch your 401k with extreme caution, and stay away from sharp objects while doing so!
So what happened?
As with anything that deals with an economy with a GDP of $16 trillion and 320,000,000 residents for whom money is spent every day, the answer is rather complicated. But simply put:
- The United States buys Chinese goods.
- China owns about $1.2 trillion of our $18 trillion debt, so they “lend” us money for our government to continue to function.
- On August 11, China devalued their yuan (Chinese currency) by 2%. This has the very temporary effect of making the average Chinese worker feel like he/she is getting more money.
- This devaluation really messed up budgets of anyone who does business with China. Imagine large-volume retailers like Wal-Mart and others who typically operate at 3-4% as a business model. This can cost larger companies massively. Sure enough, this devaluation sent China’s stock market tumbling. With more money flooded into the market, prices start to go up for everything (inflation).
- In order to combat the inflation, China also raised their reserve requirements for banks to lend, requiring now that most banks keep 18% of their deposits in reserve (compared to only 10% for most American banks). This means that, unlike American banks which can lend out 90% of their deposits in an inflation-inducing banking practice called “fractional reserve banking,” Chinese banks can lend out only 82%. The Chinese government uses this tool to help hold down the inflation that devaluing the Yuan would normally cause.
What is next?
That also is a bit complicated. The United States really has little it can do about China’s monetary policies. The only tool really available to the U.S. is to begin imposing tariffs on Chinese goods sold here just as China does to America goods sold in China. China generally imposes a 20% tariff on luxury goods, for example, but the U.S. almost never charges high tariffs like that. It’s a bone of contention between the two countries.
Bottom line: in the absence of any real economy-moving new technology, nor new natural resources we can use to move our own stock market up, our stock market will be highly subject to China and to the economy of any other country whose goods we purchase and enjoy.
And again, as news comes out, stay away from sharp objects.