For most of the 30 years I’ve been watching China-related securities, the mainland stock markets have been an afterthought for virtually all foreign investors. The same for the authorities in Beijing, as far as I can see. They seem to have regarded the equity markets as a vehicle for funding moribund state-owned enterprises that no bureaucrat in his right mind would give money to.
The mainland markets have gradually morphed over the past decade into something more interesting, as smaller, more innovative firms elbowed their way in. But the market remains very hard for foreigners to gain access to, and is arguably still not worth the trouble. The real action remains in Hong Kong.
Last year, faced with a bubble in the domestic property market created by a flood of investment money with no place else to go, Beijing decided to redirect this flow of funds to the Shanghai and Shenzhen stock markets.
In solving one problem, however, Beijing created another.
The issue was partly that the mainland exchanges were going through the roof in US-internet-bubble fashion. In addition, however, the rise was fueled in large part by borrowed money. Worse, this consisted not only of official margin lending but also by huge amounts of sub rosa margin disguised as either uncollateralized borrowing or debt secured by businesses or property. No one knew how large this total debt was–only that it was gigantic, and that inexperienced retail equity investors had leveraged themselves to the sky because they had taken government encouragement as a guarantee against losses.
As/when the market peaks and begins to decline, margin loans come due. When speculators can’t add more money to margin accounts (as is inevitably the case), this triggers forced margin selling that feeds on itself and turns into an avalanche of downward pressure. Once selling starts, it can be almost impossible to stop. Of course, as soon as potential buyers realize what’s going on, they withdraw and wait for the market to hit bottom.
This precarious development in Shanghai/Shenzhen is not a unique phenomenon. The same thing happened in 1985 in Singapore/Malaysia, in 1987 in Hong Kong, and in 1997-98 in many smaller Asian markets. In hindsight, Beijing could possibly have averted the crisis by raising margin requirements and by cracking down on unofficial margin loans by financial institutions. But it didn’t.
Beijing seems to me, however, to have followed the standard protocol for dealing with a mammoth overhang of margin selling and restoring order to the market, namely:
- identifying and cutting off borrowing sources
2. prohibiting short sellers from exacerbating the problem by speculative selling
3. buying enough stock, either directly or indirectly, to reduce forced selling to a level that the market can handle unaided
4. allowing the market, once functioning again, to clear by itself.
The way I look at it, we’re in #4 now.
One other comment:
in the US, the rise and fall of the stock market is regarded as the most powerful leading indicator of future economic performance. I don’t think that what’s going on in Shanghai/Shenzhen stock trading has much macroeconomic significance. Rather, the China stock market fall is an obstacle that every emerging market encounters on the way to stock market maturity.