China is a case study in how, apart from a handful of theoretical economists, no one really believes in a free market
Has anyone else ben tuning into the bemusing spectacle that is the Chinese stock market implosion?
It seems that the Chinese government has effectively nationalised its stock market. People thought shares were disconnected from reality before. Now that disconnect seems permanent.
And China will dodge some short term pain here, but only by throwing credibility and it’s dreams of becoming a first-world financial centre on top of the grenade.
And so it’s just not clear what all this means. It certainly makes you stop and wonder about the shape of the Asian Century. China will continue to dominate affairs in the region, just through sheer size, but China’s economy looks more and more like a derailed freight train.
Still moving, and a force to be reckoned with, but who knows where it’s going to end up.
Over the past year, the Chinese stock market has been a classic suckers game. The boom was on. Every man and their shoe-shine boy was piling everything they had into the stock market. And the government was more than happy to leave the money taps on to – to try and generate a bit of pop in the consumption numbers.
As a result, the Chinese stock market went stratospheric. Share prices tripled in just 12 months. At the peak, half the companies listed on the Shanghai and Shenzhen exchanges were priced above an indecent 85-times earnings!
The smart money started bailing out. As it always goes in these things, it’s the shoe-shine boys, the farmers and office clerks left holding the baby.
With the institutional investors heading for the exits, prices started to teeter. The Chinese government freaked, and the central bank tried to juice the market even further by cutting rates and relaxing bank reserve requirements.
(That’s right, just as the financial system was coming under attack, the government dropped reserves. Banks don’t need all of those safety measures. They just get in the way.)
Rate cuts had always worked in the past, but the run was on, and prices were still falling.
So the government got it’s own hands dirty. It rallied the major brokerages to form a $19 billion fund to buy shares and waded directly into the market, on a massive buying spree.
But that’s the thing about panic moves like this. Once the people saw the government in panic mode, they wondered what the government was scared of.
And so now it wasn’t just the institutional investors. The mums and dads were heading for the exits as well. Prices were heading south fast.
And when the tide goes out you get to see who’s swimming naked.
And the feedback loop came through margin lending. Chinese punters were borrowing in large amounts, from both brokerages and more shadowy sources — like “umbrella trusts” and peer-to-peer lending websites — to buy shares, with the shares themselves as collateral.
(According to Goldman Sachs, at the peak, formal margin lending alone accounted for 12%of the market float and 3.5% of China’s GDP, “easily the highest in the history of global equity markets.”)
Margin loans were a booster rocket on the way up, but a massive stone around the neck on the way down. As prices fell, borrowers started getting ‘margin calls’ that forced them to sell into a falling market, sending prices into free-fall.
Amazingly, Chinese regulators who had been trying to rein in margin lending did a full 180. They waved rules requiring brokerages to ask for more collateral when stock prices fell and allowed them to accept any kind of asset – including people’s homes – as collateral for stock-buying loans.
They also encouraged brokerages to securitize and sell their margin-lending portfolios to the public so that they could go out and make even more loans. All these steps knowingly exposed major financial institutions, and their customers, to much greater risk.
So in the face of a major market melt-down, the government is actively encouraging people to take on more risk!
But wait, that’s not all!
China launched a ‘war on stocks’ and took that war nuclear. They closed down the market and outlawed selling. About half of China’s 2,800 listed companies filed to suspend trading. Chinese regulators also banned major shareholders from selling any shares for the next six months. They then directed companies to start buying back their own shares and instructed state-run banks to provide whatever financing was needed.
Then in came China’s Ministry of Public Security – the thugs usually responsible for crushing political dissent. They announced that they would arrest what it called “malicious” short-sellers. But it was clear that this meant anyone whose selling (not just “short” selling) interfered with the government’s efforts to boost prices.
The market stopped dead in its tracks. Chinese brokers refused to accept sell orders for fear of angering the authorities.
Ultimately the government won. The stock market ‘stabilised’.
But it’s only a ‘market’ in a pretty loose sense of the word now.
It’s wild stuff.
And China’s commitment to ‘market forces’ has been show to be pretty weak.
Part of me thinks that this all puts China back 20 years. It’s like the saying goes, market forces are the worst possible way to allocate resources – apart from all the other options ever experimented with in human history.
The Chinese economy is huge, but it needs to get even bigger. It’s still very early days in China’s development. Chinese citizens are still a long way from enjoying first-world life styles.
But it gets harder and harder to centrally manage an economy at these proportions. It’s hard enough to know what your economy and people need, let alone navigate the rat swarms of vested interests to get those things done.
But let’s not get too holier-than-thou. Governments, banks, big business – everyone’s got their finger in the pie, in every country.
It’s just in China, no one’s pretending otherwise.
Crazy days.
Where to for China from here? What does it mean for us?
ron says
jon…the s.ex in china is a very small part of their economy. look out for mid october..when china is invited to be a member of the reserve currency club….in a huge way…the rimnimbi (yuan) will dominate the world currency markets ..and decimate the US economy. china now has the largest economy in the world. ..it surpassed the US last year…the americans owe china over 3 trillion dollars….world currency markets are much more valuable than all the stock markets around the world…by 20 times..it is huge.
remember when the swiss made their move a while ago with their currency shift…total mayhem ..that is only about 1% of the action you will see in october…so you can see my point? its all hidden behind smoke and mirrors now…oh australia is in the world reserve club..about 1%..yippee! cheers until next time:-)
Jon Giaan says
you got the inside running on something we don’t know about Ron?
Ed Burton says
No Jon, This is well known in investment circles:
1. It “may” not happen (but I think it will) – it has to get “approved”.
2. It is not a surprise to currency traders like the Swiss was (i.e. a lot people know it could happen whilst the Swiss thing was a shock) but what Ron says is true, it will be large, but will it “shake” the currency markets a lot, who knows? (if I did know I could make a lot of money!!)
Scott says
China’s is playing the art of war on a global economic level don’t believe
What you see it’s engineered
Hugh says
Of course China is waging a financial (and other) war on other nations, while trying to be careful not to burn its own fingers in doing so. As part of this it’s buying up a variety of things overseas, from properties, mines, farms to businesses etc. And they don’t think or abide along European based “rules”.
scott says
Right down to cheep crap designed to brake after you buy it
Draining you income and closing down our businesses a multi pronged attack on democracy and free trading over decades
And our way of live and freedom the loser.
Simon says
imagine trying to convince an american 30 years ago that they would borrow so much from china they couldn’t pay it back,
in the 70’s, 25% of americans employed in manufacturing, today 5%, 22 million employed in govt. that’s got to be good for the economy
pity they made manufacturing virtually illegal in australia, we have 50% more in govt. per capita than the US, but we’ll take longer to bankrupt, because we have more mining and agriculture per capita
Kathy says
I agree with Ron. When China are in the Special Drawing Rights (SDR) club, they will be a force to be reckoned with, and the US$ will be under threat when they start dealing with other countries without having to use the current global “reserve” currency of the US$.
Also, China’s “official” gold holdings were not as high as most people expected, which has caused gold prices to tank somewhat. However, China is still the largest gold miner in the world and not one ounce leaves the country. When the time is right they’ll announce their real holdings.
The Chinese stockmarket, while important and there are still some great Chinese companies that are currently undervalued, are small bikkies. The main reason the stockmarket went ballistic and therefore into overvalued territory was because the Chinese officials were trying to deflate the Chinese property bubble, so investors looked elsewhere for returns.
Exactly the same thing is happening here and everywhere else. When interest rates are artificially kept too low for too long, people will look elsewhere for yields, and therefore inflate other asset classes, quite often to bubble territory.
Beware the law of unintended consequences.
Simon says
should there even be a stock exchange? should rich have to do more than be rich in order to increase their wealth, like start a biz, invent something?
china’s richest village, eventually combined the worst of capitalism and socialism, rules for everything, and poor workers under rich oligarchs, but what an achievement otherwise
http://www.independent.co.uk/news/world/asia/huaxi-the-socialist-village-where-everyone-is-wealthy-6290583.html
ron says
hi jon, i didn’t mean to be a smart arse..lol…its just that i read a lot of stuff one cannot read in the newspapers and ..heaven forbid..see on the tv etc . etc. my ‘in box’ is full of friendly info. from people who seem to know things. strangely, most of what they write to me has been true and well documented. (6 years of it!) so i cannot argue. mark twain said(i think) if you don’t read the newspapers you will be uninformed, if you do read the newspapers you will be misinformed. funny man…for an american. i think that the internet services have given ‘us’ a valuable insight into world affairs. certainly i know more about things that i did previously. thank you for your column..its very insightful and at times very humourous. with china…they are playing their usual chinese checkers with the world at large. a good book to read would be ‘1434’..telling of the chinese armada of some 2,200 ships, some large some smaller, that sailed to venice via the suez canal.(1434 a.d.) taking with them much silk and spices for trading along the way. also they carried many, many young chinese ladies for whatever purpose i cannot imagine:-) upon arrival in venice many young ladies jumped ship and made there way to the houses of dukes and lords etc. and were employed as housemaids. of course the young men of venice found their looks rather intriguing(sort of beautiful). many world maps were given to the head of state in venice. a map of the americas found its way to king philip of spain..who in turn gave it to greedy guts christo columbo. who sailed across ‘the pond’, in american parlance, and ‘discovered’ america..which is total b.s. because he had a map and he was told what to expect when he arrived in the carribean and please read ‘russka’ by david rutherfurd…it will give you much info on how russia and ukraine developed. another problem with the western press. we keep slandering those people…with misinformation. kind regards, ron