Is China’s stock market bubble bursting?

In the last number of weeks $3.2 trillion has been wiped off the value of China’s shares. The following article, written by an author for at the beginning of July, looks at the reasons behind this tumble in share prices.

“Before leaving the world, I wish to say I concede defeat. With capital of 1.7 million yuan and four-times margin, I bet the entirety on China Railway Rolling Stock Corp (CRRC). I have only myself to blame, nobody else.”

So reads the suicide note left by a 32-year-old stock market speculator from Hunan who jumped to his death in early June after losing his life savings within two days. The man took out a huge loan worth four times his own capital from a ‘grey market’ lender. Believing the government’s gargantuan ‘One Belt, One Road’ plan was a sure fire bet, he staked everything on the state-owned railway carriage builder.

So-called margin debt has exploded in the past year, fuelled by China’s major banks that have all rolled out ‘products’ to feed this monster. This has been an important factor driving the unprecedented stock market boom of the past 12 months which long ago assumed bubble proportions. Recently, the Chinese regime has become nervous about the extent of margin debt and its potential to cause an even bigger market meltdown. The brokers and loan sharks that finance margin trading can call in the loans when borrowers incur losses, forcing them to sell more shares which acts to magnify a selloff in the market.

China’s share prices have begun to recoil on the growing realisation they have hit extreme levels and this turnaround has been reinforced by the government’s crackdown on margin trading in recent weeks, which by reducing liquidity in the market has punctured the bubble. The collapse in share values since the middle of June – falling almost 19 percent in two weeks – was the worst since 1996. Only the Greek stock market was more volatile in this period. According to the Wall Street Journal China’s market correction “has wiped away US$1.25 trillion in market capitalisation, an amount roughly equal to the size of Mexico’s economy.”

Bubble waiting to burst

In early June, China’s stock markets hit a 7-year high with the Shanghai Composite Index passing the 5,000-level for the first time since January 2008. This was applauded as the biggest ‘bull run’ in the history of any stock market with the larger Shanghai stock market rising 150 percent in one year and Shenzhen almost tripling. The combined value of the companies listed in Shanghai and Shenzhen soared to over US$10 trillion – second only to Wall Street. “No other stock market has ever grown this much in dollar terms over a 12-month period,” declared the Washington Post.

Many commentators, including Socialist magazine, predicted that this was a bubble waiting to burst. The performance of the stock market is completely at odds with the real economy – of production, foreign trade, investment and consumption – which continues to slow rapidly. The National Academy of Economic Strategy (NAES), a government think tank, is forecasting second quarter GDP growth of 6.9 percent – below the government’s 7 percent target. Many independent forecasters believe the real level of growth is lower still.

Chinese stocks fall 19 percent in June
Deflation, which means falling prices, is tightening its grip on the Chinese economy according to the data of recent months, and this worsens the outlook for company profits, consumer spending and the debt burden. Despite three interest rate cuts by the central bank, PBoC, in seven months (and a fourth cut as this article was posted) and other measures to ease the pressure upon highly indebted companies, the real cost of lending is rising as a result of deflation. The annual debt servicing costs of China’s non-financial companies is now equivalent to 15 percent of GDP, a gigantic burden. The country’s debt-to-GDP ratio, at around 280 percent, is twice as high as Greece.

This debt burden prompted Beijing to generate a stock market boom to provide an alternative source of funds for over-leveraged companies and to take pressure off the overextended banking system. For more than a year, the Chinese regime has engaged in manipulation of the stock market on a massive scale, learning from the experience of other governments. Last year, Japan’s Shinzo Abe channelled more than US$1 trillion from government pension funds into the Tokyo stock market to add fuel to its bull market. In 1998, Hong Kong’s central bank, the HKMA, engaged in large scale stock market manipulation to push up share values which had fallen by 50 percent in the preceding months and threatened to trigger a currency crisis. Beijing has engineered the latest stock market boom by implementing a succession of regulatory changes (such as legalising margin debt in 2012) and a campaign by state-controlled media to ‘talk up’ the market. The effect of these changes has been to unleash speculation on a staggering scale.

Desperate policies

Reflecting an increasingly desperate search for policy alternatives to rescue the Chinese economy from a looming debt and banking crisis, Beijing hopes to use a booming stock market to generate the funds to recapitalise debt-laden state-owned companies. The state-owned banks are themselves in need of capital injections and are no longer able to shoulder this burden. In order for this to succeed the stock market must continue to attract new sources of ‘investment’ especially from the private sector. This is also why Beijing is moving faster to open up its stock and bond markets to foreign capital through an ambitious but ‘controlled’ liberalisation. A frothy stock market that is open to foreign speculators is also seen as a way to increase the use of the yuan and yuan-denominated assets in the global financial system and so help Beijing to secure global reserve currency status, with which to reduce its dependence on the dollar.

The June crackdown on margin lending reflects a growing fear that frenzied stock market speculation is now impacting the economy in a number of negative ways. One of these is that increased liquidity from successive interest rate cuts has not found its way into new investment or a pickup in housing sales, but has instead further inflated the stock bubble. “Money has abandoned the real [economy] and entered the fake [financial assets],” reads a recent report from state-owned Haitong Securities.

Beijing is torn between the twin dangers of an uncontrollable bubble on one hand and a market meltdown on the other, which would likely spill into the wider economy. Its actions are therefore akin to a driver shifting repeatedly from the gas pedal to the brake. This explains the central bank’s decision to cut benchmark interest rates again on Saturday 27 June by 0.25 percent, to their lowest ever level, along with a 50 basis points cut in banks’ reserve requirement ratio (RRR), moves obviously aimed at halting a stock market implosion. “If they had not acted, on Monday there would have been real panic in the stock market,” Shen Jianguang of Mizuho Securities told the Financial Times.

Shadow banks – again!

The stock market bubble has also opened a new lucrative field for the shadow banking sector, which Beijing has been struggling to suppress as a potential trigger for a wider banking collapse. As in the case of the Hunan suicide, shadow banks have moved to fill the demand for high-risk stock market bets, offering margin loans that breach the government’s limit of 100 percent of a borrowers’ capital. In the so-called ‘grey market’ rates of 4-to-1 and even 10-to-1 are being offered for what are extremely short-term speculative bets – an example of the insanity of the capitalist ‘market’. Officially, margin debt accounts for 2.2 trillion yuan, up from 403 billion yuan a year ago. But while even this fivefold growth is a cause for concern, this sum is “only the tip of the iceberg” according to the Financial Times.

The main source of funds for margin trading is from a new generation of Wealth Management Products (WMPs), sold by banks and trust companies as a form of ‘structured deposit’. This practice is hair-raising even by the standards of Wall Street’s financial witch doctors. China’s debt crisis was fuelled by dubious WMPs linked to infrastructure and other construction projects, often ill-advised and based on inflated land prices, but the new strain of WMPs are based solely on speculative bets on the creation of fictitious wealth. By cracking down on these practises, however, the government sparked a stock market correction that threatens to torpedo its grandiose plans.

Beijing’s stock market gamble can have deep social repercussions. State media report that 33 million new trading accounts were opened from the start of January to the end of May 2015. Spurred by media hype, millions of ordinary Chinese have jumped into the market. There are numerous cases of homeowners selling their houses to get into stocks and even farmers and migrant workers entering the market. A survey from Mizuho Securities Asia says that three out of ten college students are now playing the stock market. These are the classic signs of a pyramid scheme that eventually exhausts itself and implodes, leaving its newest recruits as the biggest losers. The big corporate players have already banked billions from the stock bubble and can afford to be more cautious. They are also privy to information from government sources that is not available to mere ‘mortals’.

China’s stock market mania is a further sign of the economic catastrophe being created by the measures of the billionaire-led one-party regime, which can only be answered by mass struggle and socialist policies to reorganise the economy in the public interest.

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