Why China's share slump affects the world

A slump in Chinese shares has prompted stock markets across Asia, Europe and the US to fall sharply. Why is this so significant?

What's behind the fall in China?

The wider story is that China's economic growth is slowing and there are concerns that the transition to a slower and more sustainable rate of growth might be disruptive.

In addition, there has been a boom in the Chinese stock market which saw the main Shanghai index more than double in the 12 months up to mid-June. It was, in part the result of share buying with borrowed money so when the market started to decline many investors decided - or had - to sell investments to pay back debts. That magnified the initial fall.

There is often some specific factor driving shares lower on particular days. On this occasion it was something the Chinese central bank did not do. It did not take steps to stimulate more bank lending, which was a disappointment for investors who thought it would do. But there was no new stimulus and so shares fell, and sharply.

What does this mean for the rest of the world?

The direct financial impact of lower share prices in China is moderate. There is not enough foreign investment in the Chinese market for it to be a major problem. The London consultancy Capital Economics says foreigners own just 2 percent of shares.

The issue is more about whether it shines a light on wider issues about the economic slowdown in China, a concern that was reinforced by the currency devaluation earlier this month.

This is the question highlighted by financial market turbulence in China: is the economy heading for what's called a "hard landing", or too sharp a slowdown?

China is now such a big force in the global economy that it would inevitably affect the rest of the world. It is the second largest economy and the second largest importer of both goods and commercial services.

Why China crash matters in the UK

It's not just stocks.

The prices of many commodities have been affected, notably crude oil. China's problems have further pushed down the price of oil after the dramatic declines in the second half of last year. The price of Brent crude has fallen about a third since mid-June, when the Chinese stock market slide began.

China is such a large buyer of industrial commodities that the possibility of lower-than-expected sales to the country has also undermined the prices of copper and aluminium, for example.

Gold has gained ground in the last few weeks (though it is lower than at the start of the Chinese market declines in June). It is seen by many as a safe investment, protection against both inflation and more general financial instability.

The latest Chinese stock price falls have also pushed up some currencies that are seen as safe investments, such as the yen and the Swiss franc.

The dollar certainly has the potential to be affected in the same way. But the immediate impact was to make investors think that an expected interest rate rise by the Federal Reserve could be delayed because of the turmoil. The prospect of lower-than-expected returns on US assets actually weakened the dollar.

The "safe haven" effect has also reduced government borrowing costs in the US and Germany, among others.

What about ordinary Chinese people?

Those who have borrowed money to buy shares in the last few months have been hit very hard. But most people don't own shares - only one person in 30 does, according to Capital Economics.

For most Chinese the wider issue is about the health of the country's economy. If China manages a smooth transition to a slower and more sustainable growth rate, it is likely to still be fast enough to generate rising living standards for most people. A more disruptive slowdown would mean many business failures and job losses.

What might the Chinese authorities do next?

They have several options to stimulate the economy which can affect the stock markets. They could cut interest rates, they could relax the rules on bank lending or they could increase spending. They could also encourage the currency, the yuan, to fall further to stimulate exports.

How worried should we be?

Views vary about how healthy the Chinese economy is but a crisis there would be serious for the rest of the world, particularly countries and firms that export to China, which is especially important as a buyer of industrial commodities such as oil, copper and iron ore.