The Shanghai index went up 100 percent in one year. The world called it a bubble, and the fall has been equally sharp, almost symmetrically so. The losses are real money and paper money. The Chinese middle class has been investing heavily, and is taking some major hits.
One of the most serious problems is that many people have been borrowing to invest. This is common practice around the world, but in a nosediving market, it’s dangerous. One of the new rules for collateral is housing. That’s not necessarily a good thing, in a nation where prices in some areas are very high. Brokers can also now value assets like art and other personal property as collateral. It’s not a good look, in the world’s second largest economy.
If market capital takes a big enough hit, housing prices could also suffer big price falls as money dries up. A $1 million unit could be worth a lot less, and borrowing on that $1 million will mean that the loan isn’t covered if house prices fall significantly. An investor could lose the house and still be heavily in debt, in a worst case scenario.
The real money investments are vulnerable. From a look at the chart of the Shanghai index, the peak of 5,000 is almost double the pre-bubble value of around 2,500-3,000. The last time a big bubble burst, in 2005-8, it went down to its pre-spike levels. This time the market is falling almost vertically, straight down. China has also limited futures trading, another interesting move in a market which seems to have no idea of managing its own healthy directions.
Foreign investors and market analysts haven’t been impressed. The American commentators note the local Chinese companies, unlike the foreign listed companies, have “questionable” governance. Bloomberg and The New York Times note that the Chinese market doesn’t play by foreign rules, and that the Chinese problem is basically a Chinese issue, not an issue for world markets.
That’s not necessarily the case. The drying up of a lot of capital so quickly could affect China’s cost base, driving prices higher, and reducing the demand as well as the prices for imports. In Australia, we’re looking at an iron ore price which is bordering on charity, well below its peak. Chinese manufacturing may go in to slow motion, managing capital and margins in a new credit and price environment.
If you’re a China watcher, a deep sigh is hard to avoid. China has come so far, so fast; just to fall in to an accounting black hole? It’s happened before, in both Imperial China and post-Imperial days.
The good news, maybe?
There is an upside here, and it’s so bizarre that it’s almost like something out of MAD Magazine. The Chinese credit market has a “shadow banking” sector, basically a banking black market. This market is a big ugly snake among the elegant dragons, almost impossible to control. It’s the lender of least reputable, if not last, resort. Beijing hates shadow banking with good reason as a serious risk and unsightly blot to the economy, and has been trying to control it for years.
Consider this scenario:
1. Heavy borrowing for investment would have to involve the shadow banking sector.
2. The shadow banks wouldn’t have needed much of a push to get involved in a massive market rise.
3. Their borrowers will get burnt in the downward plunge, but so will the shadow banks.
The shadow banks aren’t “nice.” They’re considered virtual criminals, irresponsible, and very much part of the problem of corruption, and that’s just the media version. They’re the sort of lenders just about anyone would be happy to shoot on principle. They’ve made a fortune out of China’s prosperity, and they’re always hanging around on the edges where there’s more money to be made.
If the shadow bankers take enough of a bath, their own businesses are at serious risk. You can cover up anything when you’re making money, but when you’re losing it, you can’t. This doesn’t mean they’ll go broke, but they will be seriously weakened for a while. They’ll gouge anyone and everyone to retain their money, probably very ruthlessly. They’re likely to be about as much fun as the Triads in their ways of doing business, which is why they’re still in business.
However — a big hit to their borrowers and resulting damage to their loans will expose weak spots in the shadow banks and could expose them to serious losses. Iffy accounting and the usual half-baked tail coverage on their fraudulent books will be pretty common and pretty obvious. Things could come out in to the open which can make them vulnerable. This particular explosion in the money laundry will release some color stains which may make the shadow bankers a lot easier to find.
It’s not often in Chinese history that a financial disaster has a silver lining, but this one could be pure platinum for Beijing if it plays its cards right. It would be appropriate that this particular piece of annoying economic kuei-fen (“ghost crap”) destroys itself through its own methods.
