It didn’t take long: the frazzled People’s Bank of China tries to put a stop to the worst 2-week crash since 1996.
The whole world piled into what had been the hottest stock market in the universe. Chinese stocks had been endlessly hyped in the US and elsewhere. For the smart money, it was a game of chicken; ride it up and get out just before the crash.
Chinese stock markets had more than doubled in 12 months, propelled also by margin debt, cheap credit all around, and the irresistible desire to get rich quick. Everyone in China, from street vendors to housewives, suddenly opened margin accounts in Hong Kong and mainland China, and borrowed money to buy stocks. Outstanding margin debt ballooned to $348 billion, even while insiders were reportedly dumping stocks. A well-oiled wealth-transfer machine.
It was one heck of a party. By early June, it had created $6.5 trillion in “value” over a period of 12 months; 63% of China’s 2014 GDP!
The Chinese government continued to aid and abet that wealth transfer by touting stocks. Even in March, as stocks had already reached dizzying heights, a spokesman for the China Securities Regulatory Commission said that the soaring valuation for Shanghai-listed shares had its own “inevitability and rationality,” such as China’s “improving economic conditions.”
Then someone accidentally turned off the juice.
Over the last ten trading days, the Shanghai Composite Index has plunged 19%, including 7.4% on Friday – the steepest two-week plunge since December 1996. The Shenzhen Composite has given up 20%, and the startup-focused ChiNext Index has plummeted 27% over the last three weeks, including 8.9% on Friday. According to Bloomberg, by Thursday, margin debt has dropped four days in a row. Markets were running out of propellant.
And on Saturday, the People’s Bank of China tried to put a stop to it. It cut its benchmark interest rates by 25 basis points, to 4.85% for the one-year lending rate and to 2% for the one-year bank deposit rate. The fourth cut since November. The last cut on May 10 had stemmed a much smaller rout and had re-ignited the propellants to drive stocks to greater highs. But the descent since has been brutal.
The PBOC also lowered by 50 basis points the reserve requirements for lenders, such as city commercial and rural commercial banks, that specialize in loans to smaller businesses and agricultural enterprises. This would allow these banks to lend more. However, the PBOC didn’t cut the reserve requirements for the largest banks that control much of the financial system.
If stocks continued to plunge, it would trigger more margin calls, which would trigger more forced selling, which would depress prices further and thus trigger more margin calls…. Lu Ting, Chief Economist at Huatai Securities, told Bloomberg that this could lead “to a stampede.” But the government wanted to avoid “panic in the financial markets.”
“There is a risk of collapse in China’s stock market which has substantial margin trading and leveraged funds, and the government aims to reduce that risk,” Xu Gao, chief economist at Everbright Securities in Beijing, told Bloomberg. And in order to “reduce” that risk, the government is trying to get people to take even greater risks.
It has another very good reason to reignite the propellants and keep the wealth-transfer scheme operative for a while longer: state-owned companies that are drowning in debt need to sell shares to raise some fresh money, and for that to happen there needs to be a hot bull market with seething liquidity where speculators are buying up blindly everything they see.
Local governments too are drowning in debt. They need to issue about 2.8 trillion yuan ($451 billion) of debt this year to stay afloat and keep the economic mirage alive. They too need liquidity to do this, but that liquidity has been evaporating. Bloomberg pointed out that the Ministry of Finance last week “failed to meet its target at a bond auction for the first time since July 2014 amid the surge in municipal issuance.”
With all these issues going on, the PBOC “doesn’t want a panic caused by the stock rout to spread,” said Shen Jianguang, chief Asia economist at Mizuho Securities Asia in Hong Kong. “That would lead to financial instability.” Though financial instability is precisely what comes in the wake of an economy powered for years by monetary propellants.
In China’s real economy, meanwhile, a very hard landing is in process. Read… At Worst Possible Time, China’s Auto Exports Plunge
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
You can call it communism or capitalism, in the end it’s just a wealth transfer mechanism. The insanity therefore belong to the masses i.e. doing the same thing again and again while expecting different results.
Hi to Wolf and all of the erudite commenters on this site. Long time reader, first time poster. Thanks for all of your wonderful posts. Enthralling stuff!
I just wondered. Should China go through a panic that causes a stock market crash, could/would it likely lead to a global contagion? Is it possible that a crash in China could be containable (or have a limited effect on the Global Debt frenzy), in a way, given that so much of it’s economy is reliant on exports, and it also has high commodity inventories? I.e. The west will continue to buy what we do, and China will continue to make it. Or, does the west have a lot more at stake in the Chinese stock market, and (due to our crashing containerised indecies) not have the demand to cushion the blow to Chinese businesses/local govs etc?
Stocks going back to a rational level in a more or less orderly fashion is a good thing. Afterwards people can go back work and not be sidetracked by the mania of a stock bubble. If it overshoots on the way down, it’s a buying opportunity, which is also a good thing. Even if it’s messy, it’s not too bad. It would have some impact on China’s real economy, but not huge – and some of it beneficial. It would only have a minor impact on the global economy.
If the real economy in China were to totally crater for some reason, that would be a different story.
But a panic about the entire financial system is not a good thing because it impacts the real economy directly – see Greece. The problem in China and elsewhere is that financial systems have become dependent on precarious, over-leveraged, too-big-to-fail mastodons that take way too many risks with other people’s money. I really don’t want to see China’s financial system collapse.
China has still a long way to cut interest rates to zero. The real danger for the Chinese stock market is actually when the economy starts to recover. Until the bad numbers are coming out, there is time to party on.
“I really don’t want to see China’s financial system collapse.”
Especially not now.
To quote Bruce Willis in Die Hard:
“Welcome to the party, pal!”
China in its greed, has stepped with booth feet, firmly into the same doo as most of the west, by allowing private banks to create money, at will, through loans.
And is now increasing their ability to do so.
Can only end 1 way.
Running a system to rip-off the rank and file is NOT going to get them a transition to a domestic consumer economy and lower their dependence on exports. Maybe that’s not what they want. Maybe it’s more fun this way.
Power, greed, corruption, arrogance, obviously they didn’t pay attention. The USA should be a poster child for what mistakes not to make, but instead let’s just abuse the cattle. Central banking = White collar pick pocket. Even those at the top have to know it’s a failed system.
But once a junkie, always a junkie. Meanwhile the rest of us suffer. Many completely unable to understand the concept just keep creating the heroin these junkies desire. They defile everything that is pure and turn it to dust.
Home prices are surging again though: http://www.scmp.com/property/hong-kong-china/article/1822871/more-shenzhen-owners-decide-cancel-deals-home-prices
Hard to have a hard landing when people quickly respond to policy changes. They can do this for years and years.
1st I don’t believe any stats out of China.
2nd the re-acceleration of flat prices in China probably has to do with the equity market near blow stage with nasty 7.4% haircut last Fri alone (and long and painful march to the bottom). In other words bubble of 1 kind floating another. Housing may be played by selected well to do but the stock market “gamble” is played by all and may be the commie cadre’s worst nightmare when the mass protest with their anger vented towards the corrupt party. BTW – lot of flats remain empty as it comes with BARE interior lacking even toilet and bare concrete walls with electrical conduits. Thus the prevalence of the ghost towns…
3rd the housing and stock market mania reminds me of the halcyon days of the Japanese market till the bubbles burst rather quickly in 1989 ushering in 20 yrs of doldrums in both markets.
Uh oh could this lead to China summer like Arab spring?
From Nomura: “but an equity market collapse would hurt millions of mid-class households and pose great danger to the economy and social stability.”
Friend of mine in China told me that just about everyone is talking and often gloating about how much “money” they made on the market with just about everyone (remember the shoeshine boys back in the 30’s) freely passing stock tips. She works for US multi-national in SZ across HK and went to her hometown in Inner Mongolia to attend funeral then to far western Xinjiang province. Some farmers apparently fret why toil in the field when they can make lot of “money” kicking back looking at candle stick and MA charts real time? And yeah I heard Chinese “gamblers” also discovered the margin account and the power of leverage. Alas what an ugly lesson when these gamblers get margin calls…
Here comes street protests and unfortunately suicides…