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CNBC, the Wall Street Journal, Bloomberg and CNN all have referred to the 100-plus percent increase in the Chinese stock market from last July to this May as "meteoric," but perhaps even more reminiscent of a meteor is the Shanghai Stock Exchange's 30% fall over a mere 15 trading days. Smoldering in the crater at the worst point were more than 2,000 companies whose trading had been halted – some 97% of listed shares1. In a decision it is very likely to regret, the Chinese government stepped in to support the market, which has rallied, at least for now.
This is not the first time this has happened. The onshore Chinese market went through a similar boom and bust in 2006-2007, and proved not to have a meaningful impact on China's growth. This time is likely no different on that score. The excitement in Shanghai and Shenzhen is not, in and of itself, particularly important for the Chinese economy, let alone the global one. But it is meaningful in exposing the reality that the thesis that the Chinese economy is run by competent technocrats has its limits.
Five key factors are important in understanding the Chinese markets' run-up and fall.
Limited investment options, unsophisticated retail investors, high levels of debt and optimism about fireworks companies cum lenders and their ilk formed a heady brew that propelled the market to remarkable heights and made it vulnerable to a fall. While this has been fascinating to watch, for the Chinese economy this probably doesn't mean much. Only around 50 million people have stock accounts in China, around 5% of the population. The margin debt levels, while large relative to the stock market size, are small relative to the banking system. China's economy may indeed be slowing but its link to the stock market is mostly coincidence.
What is more concerning is how the Chinese government has reacted. Authorities have stepped in to directly and indirectly support the market, directing pensions and state-owned enterprises to invest in stocks. The Peoples Bank of China is providing financing to brokers to establish a fund to support share prices.
There is no legitimate policy reason to step in to arrest the pricking of a bubble in a relatively inconsequential corner of the economy. But Chinese authorities made the mistake of employing their propaganda machine to link the bull market to Xi's leadership. The government's recent backing of the market may be a short-term win – as of this writing stocks have recovered around 10% of their value – but in the long term it is bound to be a mistake. The government has now staked its economic credibility on defending indefensible prices. At this game, it is bound to lose.
To outsiders – economically this doesn't matter much. Few foreign investors have much invested in China's onshore markets. But in a significant way China's government has lost face among many foreign observers, including Oxford. MSCI has backed away from including A-shares in its flagship market indices6. The International Monetary Fund, which had indicated that the Chinese renminbi was nearing eligibility for inclusion in its Special Drawing Rights basket7, is surely reconsidering. China's government’s credibility, not its economy, is the greatest casualty of the recent rout.
1Hunter, Gregor Stuart and Ma, Wayne. "How China's Stock Market Thinned as it Plunged." Wall Street Journal. July 21, 2015.
2"China's Stock Market Bubble: A Goring Concern." The Economist. May 30, 2015.
3Verhage, Julie. "Macquarie: Chinese Margin Debt Has Much, Much More Room to Run." Bloomberg Business. June 24, 2015.
4Phillips, Tom. "Xi Jinping: the Growing Cult of China's 'Big Daddy Xi.'" The Telegraph. December 8, 2014.
5"China's Stock Market Crash: A Red Flag." The Economist. July 7, 2015.
6Moore, Elaine and Noble, Josh. "China's MSCI Hopes Soured by Stock Rout." The Financial Times. July 17, 2015.
7Mitchell, Tom. "Stock Market Rescue Places China's Renminbi Reform Under Threat." The Financial Times. July 12, 2015.
The above articles represent the opinions of the authors as of 7.30.15 and are subject to change at any time due to market or economic conditions or other factors.Print