The Chinese market: “The ultimate battle between capitalist fear and a communist government”

30th July 2015


Darius McDermott, managing director at fund broker Chelsea Financial Services and Mindful Money Columnist examines the turmoil engulfing the Chinese stockmarket…

In just over one month $3 trillion has been wiped off Chinese stock markets. The collapse follows a 150% rise in the Shanghai composite over the past 12 months – a state sanctioned government rally, fuelled by borrowed money and margin-based financing (borrowing money to buy stocks).

The regulator was asleep and, by the time they cracked down on margin lending on the 13th June, it was already far too late. What followed was a 40% correction in the Shanghai and Shenzhen markets. The Chinese governments reaction to the crisis has been extraordinary and, rather than accepting the necessary pain of deleverageing, is instead doing everything it can to re-inflate the bubble:

A policy disaster or smart stock-market management?

The Chinese communist party is used to winning, but has it finally met its match in the form of the capitalist stock market? Never in the history of stock-market crashes have we seen the level of measures which Beijing has announced. The question is, will they succeed where every other government has failed in the past? Who will ultimately win the battle, communist government policy or the animal-driven capitalist fear of a falling market?

In its latest, and most controversial measure, the Peoples Bank of China has begun lending directly to the China Security Finance Corporation to fund share purchases. This means the government itself is now borrowing money to buy shares directly in a desperate attempt to prop up the market. Effectively this is the ultimate extreme form of quantitative easing (QE).

History is not on the side of governments when it comes to controlling stock markets, but then no government has ever had the same level of control and power as the Chinese government. It may well be able to engineer a short-term bounce but at the same time it has damaged the credibility of its financial markets.

At the moment the government has bought itself time but it will need radical reform and exceptional management to gently cool the stock market from its over-leveraged position and return to normality. I suspect we will witness continued volatility going forward.

The greatest risk is undoubtedly the impact that any crash might have on the Chinese economy, which would have wide-ranging consequences. In my view the Chinese economy is of much greater concern than Greece. There is no comparison between the two economies in terms of size and importance. The Chinese economy is now the second largest in the world. Any collapse in the economy will likely send global stock markets into a bear market so the situation is something all investors should be following closely. Currently, the consensus is that the wider economy and stock market are only loosely correlated, however the government’s efforts to re-inflate the equity bubble are increasing these risks for the future.

In the short term the Chinese government will probably successfully drive the stock-market back up, but this will only postpone an even bigger correction in the future. If I have learnt anything from working in financial markets, it is that artificially distorting assets has consequences. I would not be surprised if the Shanghai composite rises above its previous peak. If this does happen in a short space of time I would be extremely wary and it will only be a matter of time before Beijing is overwhelmed by animal spirits. However, if the government uses the time it has bought to crack down on margin lending, shadow banking and other problems in the system, they may yet be able to manage the stock market effectively.

1 thought on “The Chinese market: “The ultimate battle between capitalist fear and a communist government””

  1. Jive Bunny says:

    The Chinese economy and the Shanghai and Heng Seng seem to exist in parallel worlds, accordingly there should be little risk of contagion between the 2 entities although the economy is threatened by poor money growth and falling commodity prices, where many firms are borrowing in the real economy using iron ore etc which they have bought as collateral. This is where the threat to the real Chinese economy comes from.

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