The crisis was the inevitable conclusion after an unprecedented bull market that skyrocketed China’s stock market beginning November 2014 and peaking on June 11. The market plunged by about one-third in the last month. Altogether about $3 trillion USD has evaporated from market value.
Asset bubbles inevitably burst and China’s situation has followed a familiar path. What is important is what is the impact of the market slide on China’s real economy, which is in the process of reform.
Many economists believe that China’s stock market bubble was engineered by the government. Trading rules had been relaxed, which enabled investors to buy shares with borrowed money and using multiple accounts. The government’s involvement in supporting the stock market may be at odds with market corrections that occur in markets in other countries.
Another challenge for stock market rebalancing is how Chinese authorities stake their reputation and authority on the stock market. The manipulation of the Chinese government was less about bolstering the actual economy and trying to spike the markets, which make good press and citizen goodwill. The Chinese press reportedly has silenced any headlines about panic over the stock market.
“China’s stock market had become detached from the reality of China’s own economy, and appallingly overvalued,” Patrick Chovanec, managing director at Silvercrest Asset Management tweeted, according to CNN.
Despite the drama around the plunging stock market, it still plays a relatively small role in China. The free-float value of Chinese markets is around one-third of GDP, as compared with more than 100 percent in developed economies.
Less than 15 percent of household financial assets are invested in the market, which is why fluctuating prices have little effect on consumption.
The group that will suffer the most are China’s 90 million retail investors who became swept up in the furor and borrowed heavily to trade in the stock market.These investors were generally young, inexperienced and the majority did not have a high school education. While the government pushed for such investment, these speculators who preferred to buy stocks on margin, are the ones to pay.
Not all news around the stock market is all bad. Some analysts point out that the Shanghai Composite Index remains 72 percent above where it was 12 months ago. While others call the recovery a “dead cat bounce,” meaning a fleeting rise after a stock fall. In metaphorical terms, a dead cat thrown from a building will bounce, but doesn’t mean it’s alive.
Economists are expressing concerns China’s continuing sluggish economy and doubt the nation will achieve the predicted 7 percent growth in the gross domestic product. On Wednesday, China will release economic numbers on GDP from the second quarter on Wednesday. The stock market drama may give a small bump in June numbers due to brokerage fees, but that’s not the kind of growth that would build the rest of China’s economy.
An unanswered question is the future of China’s economy and whether the leadership will make good on promises to enact long overdue economic reforms.
