Monday, 24 August 2015

The Great Fall Of China

  • China's benchmark Shanghai Composite index is down more than 8 percent in Monday trading. The market is now down 38 percent from its June peak.
  • Over the last month, the Chinese government has taken extreme measures to reverse the stock market's decline — but these measures now appear to be failing.
  • The decline in Shanghai is part of a worldwide selloff. Stocks in Japan, Taiwan, Hong Kong, South Korea and Australia all posted big losses, and stocks are also down in major European markets.

China's stock market had a debt-fueled boom, followed by a crash

  • Between June 2014 and June 2015, China's Shanghai Composite index rose by 150 percent. A big reason for the stock market rally was that a lot of ordinary Chinese people began investing in the stock market for the first time. More than 40 million new stock accounts were opened between June 2014 and May 2015.

  • And many have been buying stocks with borrowed money. The Chinese government used to strictly limit this practice, but over the last five years the government gradually relaxed those regulations.

  • Earlier this year, the authorities became concerned that the stock market's rise had become unsustainable. So they began to tighten limits on debt-financed stock market speculation. The stock market peaked in June and then began to fall quickly.

Efforts to prop up the market haven't worked

By early July, the market was in freefall and the Chinese government began to panic. The took a number of stepsto push stock prices back up:
  • The central bank provided more cash to the China Securities Finance Corp, a state-run company that lends people money so they can buy stocks.
  • Initial public offerings were suspended, so that newly issued shares wouldn't compete for capital with those already on the market.
  • Companies' major shareholders — those with more than 5 percent of a company's shares, as well as executives and board members — were banned from selling shares for six months.
  • China's securities regulator ordered companies to either buy their own shares or encourage their executives or employees to do the same.

Those efforts seemed to work for a few weeks. The Shanghai Composite rose from the July 8 low of 3507 and seemed more stable. But that proved to be a temporary reprieve. Last week, the market began to plunge again.

Once again, China tried to prop up the stock market, announcing that a major state pension fund will be allowed to invest in stocks for the first time. But the market was unimpressed with the announcement.

No government likes to see its stock market crash, but the plunging Shanghai Composite will be particularly embarrassing for the Chinese authorities. Positive coverage from state-run media helps to fuel last year's stock market boom, and last months' decision to intervene in the stock market tied the government's prestige even more tightly to the market's performance.

The Chinese economy is struggling

The broader Chinese economy isn't doing very well either. Official figures show the Chinese economy growing at a 7 percent rate in the second quarter. That's slow by Chinese standards, and many Western economists suggest that the official figures overstate China's growth.

Weak Chinese growth has exerted downward pressure on China's currency. The Chinese central bank allowed the currency to fall by 3 percent earlier this month.

For the last two decades, China has benefitted from an export-oriented growth strategy. But exports can't power China's growth forever — world markets just aren't big enough. So China needs to transition to an economy that's powered more by domestic consumption. And as Vox's Max Fisher has written, the economic reforms required to facilitate that won't be easy.


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