The falling Chinese stock market is a frightening spectacle, given that China has been a driving force behind global growth for decades. But it isn't likely to amount to the long-term, worst case scenario that is rousing fears in the media.
In fact, what we may be seeing is part of a larger and necessary rebalancing that all rapidly growing economies must eventually undergo – amplified in this case to the extremes that have come to characterize China's rise.
Whereas the U.S., along with other developed economies in the West, have been running current account deficits since long before the financial crisis of 2008, China has been running a massive current account surplus -a sort of reversal of historical balances between established and emerging economies.
For years now, China's model for growth has been to reinvest GDP into assets expected to stimulate growth, and it has responded to equity pullbacks with easy money policies like rounds of quantitative easing – a strategy that now appears to have reached the point of diminishing returns.
China has essentially been pursuing an "if it ain't broke, don't fix it" approach, by continuing to leverage cheap exports, foreign investment, easy money, and government directed reinvestment whenever it wants to spur growth. And for years now, this approach has been effective, but has caused observers to raise questions about its long term sustainability.
But China isn't running head on into the fundamental changes that are demanded of an economy after it transitions from "emerging" status to being the largest in the world. You can only get so far on central planning while ignoring the giant proportion of the population that is left out.
This sudden downturn may be the start of – or may become a catalyst for – an important shift that must occur, wherein China has to spend some of its surplus savings through fiscal policy to assist the large swaths of the population who are unemployed and not consuming.
China's national savings rate is among the highest in the world, and a large proportion of that is made up of household savings. The people in China are afraid to spend money for fear they will need it in the event of an emergency.
By spending money on safety-net programs and other forms of fiscal stimulus, China will not only help to build its consumer economy – the necessary next step in the country's development, but it will also mitigate the political risk that has been bubbling under the surface, promoting skepticism among investors who understand the situation on the ground.
For this reason, the China story will likely inspire a flight to safe havens, like gold, for the short term -and we may well see a rally in gold over the short term. But over the longer term this pullback could well create buying opportunity in China-related investments.