“Greece is a thriller, but China is a horror show”

It is possible that, seeking to draw attention on what was happening in the heart of the Asian giant, at a moment when the comings and goings of the Greek debt crisis monopolize the headlines of the international press, an Australian journalist chose this striking headline for his article on the serious losses on the Shangai and Shenzhen stock exchanges. Despite the more and more desperate efforts made by Chinese authorities to bring the movement to a halt, the dynamic is continuing and could very well affect other Asian stock exchanges.

jeudi 9 juillet 2015

Authorities Struggle to Slow Panic on the Stock Exchange

Chinese markets are free falling. The country’s main stock index fell 32% in less than a month after a fall of 6% on Tuesday, July 8. A real disaster for many Chinese who rushed to buy up stocks in the past months, but also for the government that is now seeking to contain at all costs the explosion of a bubble that it alone created.

Beijing has taken many kinds of measures in order to counter the stock exchange losses : lower interest rates with the central bank, suspension notices for planned initial public offerings, reduction of financing conditions for transactions (houses and antiques are now acceptable collateral)... The main brokers and investiment funds promised to buy back some of their own shares in order to support prices. Put otherwise, this brutal intervention in the markets put in place since Wednesday has been less than successful. To such a point that, in order to put a stop to the markets’ precipitous declines, the best solution was to simply suspend stock exchange listing. Starting Wednesday, more than 500 businesses that trade publicly in China announced the suspension of their public offerings, the number of suspensions currently representing nearly half of all publicly-traded companies in China, excluding Hong Kong. Most suspensions concerned the Shenzhen stock exchange, which is dominated by small businesses. More than $1.4 trillion have been frozen by these suspensions, being about 21% of all Chinese capitalisations. These suspesions have become the most useful way of halting the losses on the stock exchanges. In reality, if they did not exist, it is quite possible that the 28% loss on the Shangai exchange since June 12 would be considerably higher. Using June 12, when the exchanges’ values hit all-time highs, as a reference point, the total of all losses attains nearly $3.2 trillion, being more than the capital traded in France and Spain together.

The Artificial Creation of a Stock Bubble as an Answer to Economic Slowdown

The slowdown of Chinese economic activity has led to a series of monetary and fiscal measures aimed at stimulating grwoth and investment. These measures pushed stock indexes to a level of “irrational exuberance” worth of those that China so severely criticized and caused the fiasco on Wall Street in 2007-2008 with the subprime crisis.

Indeed, faced with the signs of an economic slowdown, frightened Chinese authorities took a series of monetary and fiscal measures, such as the lowering of reserve requirement ratios – in order to stimulate the recourse to credit by making loans easier to obtain – decided by the central bank. Fiscally-speaking, a series of measures for the overheating real estate market was adopted, including lowering effective down payments for first-time buyers (from 30 to 20% of total) as well as for secondary residences (from 60 to 40%). These solutions are similar to those put in place by all central banks in order to artificially support an economic model at the end of its rope and to create a false impression of security that allows stock markets to skyrocket.

All the ingredients were gathered to make the bubble swell. The stock exchange boom was artifically created by Beijing. Authorities used every means, including state propaganda, to incite more and more Chinese citizens to invest in the stock exchange. Risky practices, including buying stocks on credit, were encouraged, which created a serious instability.

All of a sudden, stock exchange madness had spread to China. The proof : the volume of negociations took off and was four times greater than the daily average on the New York Stock Exchange (NYSE). The opening of new accounts in order to trade on the exchange developped at a rhythm of more than a million per week ! Not less than 8 million new brokerage accounts were opened during the first quarter of this year, and 4 million others during the last week of May alone. According to the numbers published by Bloomberg, more than two-thirds of these new investors were not high school graduates (5.8% do not know how to read). In other words, according to this financial agency, it is taxi drivers and hotel doormen who joined the dance. A macabre dance because profit growth for publicly-traded companies did not exceed 1% this year, while their stock values were multiplied by ten.

A Real Challenge for the Unshakeable Chinese Communist Party and Potential Obstacles to Its Plans of International Expansion

In spite of their development, the immaturity of Chinese capitalist institutions, notably on financial markets, is such that on the face of the situation the current turbulence on the exchanges carry limited systemic risks of contaigon when compared with more advanced capitalist countries. Thus, the total capitalisation of the country’s stock markets – since the recent fall – represents 66% of national production. In the United States, this figure reaches 140% of GDP. However, the banks and financial institutions that loaned for “marging-trading” operations (the use of credit to invest on the stock market, interest rates being reimbursed by capital gains upon reselling) could very well be faced with payment defaults, their clients no longer being able to reimburse their contracted debts after the fall in stock values. Another potential danger concerns financing sources for private Chinese companies that are indebted up to 125% of GDP according to the US consulting firm McKinsey. For their part, public companies, which represent the major part of publicy-traded companies in China and had difficulties financing themselves through traditional means, so obtained fresh capital on the sky rocketing stock market, have now seen their plans frustrated.

Already in 2007, a period of europhia similar to today had been followed by market reversals and a contraction during the two months following the market crash of nearly 71% of the main stock references’ value. Despite the market crash and the economic shock, the economy stayed afloat. This precedent shows that the current fall could very well stabilize itself. But, beyond these numeric comparaisons, the circumstances are totally different. During the last market crash, the economy was growing at a two-figure rate. Today, the annual rate of growth is officially reduced to 7% (certain economists believe that the Chinese rate of growth during the first quarter was inferior to 6%).

In this context, Beijing was obliged to intervene in order to better regulate its stock markets and avoid the financial, social, and political consequences of a total meltdown. Despite the market’s reluctance and fears in past months, Beijing probably has the tools necessary to mangage a stock market crash. But, regardless of Beijing’s decisions in the short-term, as long as it does not put in place alternative solutions for secure investing, all of this will have long-term consequences on the slowndown of growth and private consuming, creating supplementary difficulties for its strategy to catch up to the world’s more advanced economies, especially at a moment of global economic slowdown. In order to understand these difficulties, we must keep in mind that the development of the stock market was encouraged by authorities who were responding to an excess of internal saving and a lack of investment opportunities after the real estate bubble deflated.

Lastly, and as a strategic consequence of all this, this situation reveals the weaknesses in the endless source of Chinese capital at a moment when Beijing is launching ambitous funding initiatives like “New Silk Road”. This program aims at creating economic connections and developping foreign trade between China and 65 other countries, with a population of more than 4,400 million people, depends financially upon Chinese financial institutions like the Silk Road Fund, the Chinese Bank for Development, and the China Ex-Im Bank, that all collect financing on national markets.

From a point of view of domestic stability, in the case in which the Party would lose too much face in its dispute with the “markets” and would fail to stabilize them (and, currently, it has not succeded in recuperating its legitimacy in both cases), a profond crisis of confidence could set in within the State apparatus, unfailing up until now.

What these events show us, contrary to the blind faith in the Chinese bureaucracy’s unlimited capacity of control – a question which become more and more important in the aftermath of the Lehman Brothers crisis as China succeded in maintaining a elevated rate of growth in a context of economic crisis – is that the enormous excesses of capital over-accumulation must be paid for one day or another. Especially when, in order to support the economy, one scurries into infrastructure or urbain projects that required so much ciment that it exceeded that of the United States for all of the 20th century in less than 3 years.