The Chinese stock market meltdown is accelerating despite government intervention and is blowing back to commodities markets, including copper and oil, which are trading down based on concern that the stock market plunge is a harbinger of even more economic weakness. The Financial Times gives a snapshot of today’s downdraft:
China’s central bank stepped up state support for sinking stocks on Wednesday, as investors rushed to sell what they still could after a fresh wave of share suspensions that have now halted trading in half the market.
The Shanghai Composite opened down as much as 8 per cent before paring losses to a 4.7 per cent decline by 11:15am local time. The Shenzhen index lost 3.3 per cent, while the start-up ChiNext board was down 0.2 per cent.
The renewed selling followed another round of share suspensions overnight, which have now halted trading in 1,476 stocks — or more than 50 per cent all listed companies on China’s two main exchanges. The suspensions have frozen $2.6tn worth of equity, according to Bloomberg calculations.
But even with the dramatic declines of recent days, and orders still so lopsided that trading in more than half the stocks on China’s two biggest exchanges has been suspended, China’s stock were on such a tear this year that they still have yet to give up this year’s gains As the Wall Street Journal points out, “Despite the recent tumble, China’s main stock index is up 72% over the past year and 10% since January.” But it is Not a Good Sign that the market hasn’t stabilized even in the face of central bank intervention. The financial press is using words like “panic” to describe investors’ mood, and the selling has spread to risky bonds.
It is important to understand that the significance of a stock market plunge depends both on how big the bubble got before it burst, but even more important, how much of the bubble was the resulted from levered speculation. The Roaring Twenties frenzy was fueled substantially by borrowing, often through trusts, which allowed for tremendous leverage (trusts investing in trusts). After the Crash, the US put curbs on margin lending, with the result that the 1987 and dot com busts didn’t blow back to the financial system or the real economy in a major way.*
And we don’t have very good answers for China. One of the notorious features of the economy is the lack of reliable data. Even though margin lending is high by US standards, 4.4% before today’s fall, it’s vastly below the amount of gearing in the US stock market before the Great Crash. Value Walk (hat tip Lambert) puts margin debt at 8.5% of free float, which is a troublingly high level. Ruchir Shama, the head of emerging markets and global macro at Morgan Stanley, similarly estimates margin lending at close to 9%, which he calls “the highest in any market in history.” Moreover, there is no way of knowing the degree to which the money that went into stock buys was from borrowings other than margin loans, say by borrowing against real estate. So a big loss in the stock market could lead to later defaults on other loans.
The Wall Street Journal on Monday explained why the Chinese stock market implosion is a bigger deal than it seems on the surface:
Stock ownership in China is still quite limited, and the individual accounts that dominate trading are small. In fact, the only real losses so far have been among stock investors who arrived late to the party. Economists argue over whether a full-scale collapse would have much impact on the overall economy.
Yet the government’s response revealed an urgent—some say panicked—impulse not only to protect investors but to shield the party from criticism and head off possible social unrest.
The ultimate goal of Chinese security is weiwen, or “stability maintenance,” which is another way of saying “maintaining party rule.”
And that view led to the extreme measures taken so far. From the same article:
In that sense, the unprecedented rescue moves, including a multibillion-dollar fund set up by Chinese brokerages at the government’s behest to buy blue chips, is a preview of what’s to come following the passage last week of a national-security law that massively expands the definition of threats to the state to cover almost every aspect of domestic life, including “financial risk,” as well as international affairs. The law explicitly states that economic security is the foundation of national security.
Today, Sharma argued in a Wall Street Journal op-ed that China’s Stock Plunge Is Scarier Than Greece. Key sections:
China’s state-sponsored stock-market rally is unraveling, with potentially dangerous consequences. The first major sign that all wasn’t going according to script came on June 15. Chinese had awakened expecting big gains because it was President Xi Jinping’s birthday, but the Shanghai market fell more than 2%…..
In most countries, no one thinks there is a link between a leader’s birthday and the market. That such a theory prevails in China reflects the widespread belief that Beijing’s authoritarian government can produce any economic outcome it wants. Now trust in China’s ability to command and control the economy is faltering. If trust collapses, the global repercussions could be more severe than those from the Greek debt crisis.
Yves here. If that was the sentiment behind China bullishness, it clearly chose to ignore all sorts of warning signs, the biggest being massive overinvestment in economically unproductive real estate. And worse, this bubble looks to be a rerun of the fatal Japan stock/real estate market bubble, where the central bank in each case sought to goose asset prices to boost consumption and investment. Again from Sharma:
Funneling some of China’s $20 trillion in savings into stocks was a last-ditch effort to revive flagging economic growth by giving the country’s debt-laden companies a new source of financing. The aim was to trigger a slow and steady bull run, but the somnolent stock market exploded into one of the biggest bubbles in history.
And the worst sort of rubes piled in:
Today China’s 90 million retail investors outnumber the 88 million members of its Communist Party. Two thirds of new investors lack a high school diploma. In rural villages, farmers have set up mini stock exchanges, and some say they spend more time trading than working in the fields.
The signs of overtrading are hard to exaggerate. The total value of China’s stock market is still less than half that of the U.S. market, but the trading volume on many recent days has exceeded that of the rest of the world’s markets combined.
We haven’t written about China for quite a while, but our position has long been that it would be extremely unlikely that China could avoid either a long period of sub-par growth (which would be a cause of political and social stress) or a serious dislocation. No significant economy has made a smooth transition from being investment led to being consumption led. But worse, China doubled down on its old economic growth model by pursuing policies that generated even more investment. Even though China’s dependence on exports as a source of growth diminished somewhat, the importance of investments grew. to the point that export plus investment share exceeded 50% of GDP. Some pundits pointed out that the marginal productivity of borrowing was falling, another danger sign. But as long as the old model seemed to be working, it made no sense, at least if you were an investor, to fight the tape. Again from Sharma:
Looming over all of this is China’s massive run-up in debt, which has increased by over $20 trillion—to around 300% of GDP—since the global financial crisis in 2008. All along, the bulls argued that Beijing has successfully managed every challenge to its three-decade economic boom, and that it could overcome the threat this debt represents. At a minimum, the argument went, China’s financial woes would be smaller than those of other countries with high levels of borrowing. This faith in Beijing encouraged many global hedge funds to pile into Chinese stocks.
But if Beijing can’t stop the market’s tumble, there could be a sudden shift in the perception of exactly how far economic growth might fall under the weight of too much debt. If that floor crumbles and the Chinese economy spirals downward, it will make the drama surrounding Greece feel like a sideshow. China has been the largest contributor to global growth this decade; Greece’s economy is about the size as that of Bangladesh or Vietnam.
Sharma is choosing to ignore the longer-term implications of the immolation of Greece for the future of the Eurozone, but he’s right about China’s importance to global growth, particularly for commodities producers. The Sydney Morning Herald (hat tip EM) describes some of the knock on effects so far:
The stockmarket rout has also comprehensively choked off a slight recovery in the prices of commodities like iron ore and oil, dragging down shares in resource giants BHP Billiton, Rio Tinto and Fortescue, as well as the currencies of producing nations like Australia and Canada.
Iron ore had recovered to more than $US60 a tonne from a decade-low of $US47 in April. By Tuesday, it had dipped below $US50 after consecutive days of sharp declines.
The fall in iron ore comes as construction demand in China falters and the overwhelming majority of the country’s steelmakers sit deeply in the red. Even still, major miners continue to increase shipments to China, contributing to a glut of supply and mounting stockpiles at major iron-ore ports, all while confidence is being battered by China’s free-falling stockmarket.
In further bad news for steel demand, Chinese automakers are reporting a major dent in sales, describing last month as the “worst June ever”.
Fortescue, among others, have previously cited China’s surging long-term demand for cars as a key to filling in the gap in the demand for steel vacated by slowing construction in China.
“The plunging stock market is essentially a meat grinder, shredding money meant for buying cars,” Cui Dongshu, the secretary-general of China’s Passenger Car Association told Bloomberg.
He said an increasing number of car buyers in China are canceling their purchases and risking forfeiture of their down payments.
China maven and long-term skeptic Michael Pettis thinks the officialdom has 80% odds of being able to engineer one more big stock market rally. US crisis followers will recall that our tsuris had three acute phase before the final Lehman-triggered cataclysm. It’s not obvious how China could engineer a soft landing. Propping up unsustainable financial and economic models generally leads to nasty unravellings.
Update 3:00 AM: Bloomberg published a new story after I started drafting this post. The stock market suspensions are now up to 71%:
Investors looking to sell Chinese shares have found themselves locked out of 71 percent of the market…
“The latest development of trading halts will affect investor confidence,” said Bernard Aw, a strategist at IG Asia Pte Ltd. In Singapore. “Individual traders will still offload the counters when trading resumes, unless there is a considerable change.”…
The selloff is defying increasing efforts by officials to restore confidence. China Securities Finance Corp. — which manages the nation’s short selling and margin trading — is seeking at least 500 billion yuan ($80.5 billion) to shore up equities, people familiar with the matter said Wednesday. The central bank said the same day it would provide “ample liquidity” to the market. Margin requirements were raised on small-cap index futures, while state-owned companies were ordered not to sell shares.
The authorities have “not only failed to stabilize the market, they have actually increased panic levels,” Alex Wong, Hong Kong-based asset-management director at Ample Capital Ltd., which oversees about $129 million, said by phone. “We are reducing exposure, raising cash levels and trying to stay out of the market.”
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*However, the 1987 crash was more touch and go than you might imagine. The Chicago MERC almost failed; it was saved only with a three minute margin by Continental Illinois CEO Tom Theobald being in the office early and overriding an internal (and procedurally correct) order to not fund a $400 million loan against a failed customer order. John Phelan, head of the NYSE, said if the MERC hadn’t opened, the NYSE would not have opened, and if it has closed, he was not sure it would have been able to reopen. The US Treasury market dried up to the point where the Fed called the Bank of Japan and told them to start buying Treasuries. The BoJ called the major Japanese banks who dutifully complied. The fact that the panic then impacted the Treasury market negatively is a big contrast with behavior today; market panic lead to a flight to quality and Treasuries are seen as a safe haven.
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Thanks for posting, this was easy to read and understand for a non-finance person.
This is I’m sure besides the point, but I wonder what the impact will be on housing prices here in the Bay Area. Many of the houses here (confirmed by a personal banker at our local bank) are bought by Chinese buyers paying cash well over asking price.
For every buyer there is a seller.
The buyers who have been blowing the bubble are largely the small fish – buying from the big fish. And it’s the big fish who buy foreign real estate.
And “paying over asking price” is standard in Bay Area real estate – because listings are priced under market value, to goose interest and create bidding wars.
It may very well boost it. If the panic in China spreads it will pop the Chinese property bubble hard which will likely make stable foreign investments (say U.S. houses) seem a whole lot safer.
Since there was a seller for every margin-leveraged buyer on the way up, and they get to keep their gains, what has really happened is a large transfer of wealth from the retail suckers and their margin lenders’ fund sources to those sellers. It seems quite possible that those fortunate winners are going to do all they can to get their wealth out of China, so the result may actually be an increase in Chinese demand for US real estate.
Not ‘US real estate,’ but ‘some sub-markets of US real estate.’
Some will benefit and many not (at least not directly).
Where in America would rich Chinese not want to live? Cape Girardeau? Blodgett Mills? Scranton?
Maybe those will be the places where Americans will be permitted to have a survival future within America.
Limpid writing, as the earlier commenter said. One thing I didn’t see mentioned and I’m curious about: the sheer amount of fraud on the Chinese stock exchange.
There’s been lots of fraud in the U.S. from Chinese reverse mergers. It’s practically been an industry of fraud. You get companies springing up with weird names like China Umbilical Blood and with addresses in out-of-the-way office parks or industrial garages, in Florida or Nevada, pumping and dumping and siphoning off tens of millions of dollars into Chinese BVI vehicles (usually with similarly colorful names).
And the U.S. has SEC regulations! (Don’t laugh.) Imagine how much worse it is in China. Much of China’s economy is totally unregulated. There’s an entire shadow banking sector (with links, I’ve come to suspect in my own hobby research, to shadow banking; China Fire & Security, owned last I checked by Bain, is intriguing if you’re inclined to go on a Google dig).
The proliferation of bogus Chinese companies on the Nasdaq and Pink Sheets through reverse mergers was staggering. In China, the fraud might be an undiscovered Wonder of the World.
If many of the companies on the Chinese exchanges are outright fakes, it’s not about the margin and there’s nothing the government can do.
Love to hear more.
One thing that happens when a listed company is discovered to be a fake (or becomes so obviously so that the “authorities” can no longer deny it) is that the shares get suspended.
By that token are we seeing an acknowledgement that 71% of Chinese listed Cos. are fakes ?
Very few listed Chinese companies are fakes of the sort you suggest. Listings on the Chinese markets has been brutally restricted to well-connected large private or large State Owned enterprises. However, lots of Zombie enterprises are listed with vast debt that can never be repaid. While they do have official operations, they also carry extraordinary debt loads. Corporate debt, primarily from SOEs is 180% of GDP in China. This is frightening.
The chinese stock market is but a toy for the ccp. The whole story is overplayed in the western press looking for shadenfreude. If the ssec was sitting at 2000 for half a decade, I dont think the ccp is worried that it is declining to merely 3500. In fact, putting a bit of fright into gambling investors might not be a bad thing and serves a useful lesson for the masses.
Friction.
If you go from 2,000 to 5,000 and back to 2,000, in a friction-less world (no heat loss), you are back to where you start.
Unfortunately, to make the same trip in this world (friction and all), or even one from 2,000 to 5,000 and back to 3,500, those who shorted the market will win, and those who are all-cash investors will still be ahead, but many who leveraged will be wiped out.
So, there is redistribution and as a whole, you could end up worse (either scenario).
You are one of very few who make the most sense of all comments here
Everyone acts like the Chinese investor is a rube waiting to be swindled and surely some are. But most understand the reality much better than one thinks and simply switch their selling elsewhere, to say the e-minis or DAX.
The wealth destruction is in the trillions (with a T), which cannot be easily ignored, except by the US press. Even as copper, gold, oil etc trend lower to meet margin calls the US press intently focusses on minor issues and ignores the growing tsunami that is not easily contained.
Halting trading, yup, bet that’ll cure it.
Might have been better to intervene behind the scenes rather than so openly. Quietly place leverage caps, etc. and then deal with the real problem, disappearance of the little guys’ portfolio and the accompanying drop in consumer spending. Making whole the peasants who bought a few stocks rather than the billionaires who (supposedly) should have known better.
An omnipotent being must be seen as omnipotent.
How else can you attract believers and have them keep faith?
So it would seem that all the hot money flowing out of China into safer markets like USA, OZ and NZ property were signs of weakness not strength. People at the top of the pile with better connections, information and education could see the inevitable collapse and started moving early. I’m not referring specifically to the stock market collapse, which is but a sign of the deterioration, but the economy as a whole. China could blow one last bubble to avoid the reckoning of massive mal-investment and this was it. Now we’ll probably see the one final spike of outflows as they exercise maximum capital flight and then it’ll shut down suddenly as the government steps in the prevent “disorder”.
If I were a Central Committee planner, I’d be working out the mechanisms for seizing the “Ghost Cities” and putting the displaced peasants and factory workers in them. Then, building industrial bases for internal consumption goods nearby. Or go full Green and build Green Infrastructure manufacturing sites nearby. There are definite positives to a Demand Economy if the leadership is competent.
One of China’s problems is the leadership is the old guard and the youth of the communist party are the kinds of people who didn’t decide to go into the world of private enterprise. The anti-corruption campaign was meant to appease the party congress before they turned on the existing leadership which is more of a hodgepodge of people smart enough to navigate joining a regime dominated by Mao-cultists when there were less opportunities and career paths available.
I’m not sure the leadership can lead. Richard III and Henry Tudor come to mind. Richard was ousted, but Tudor never trashed him and continued many of Richard’s policy changes. Even though, Richard was a good king for the growing towns and new merchants he came from the old order of landed aristocrats. In the end, he wasn’t legitimate for the new England. I don’t think the current leadership is legitimate for the communist party which is still on the ground in China. With wealthy Chinese preparing bug out spots, they aren’t staying to help the current leadership class. My guess is the Central Committee simply has no clue about where to go.
If you truly have farmers day trading on the hopes of securing their financial future, then I can see why the government is doing anything it can to prevent an all out crash in the stock market. My understanding of the Chinese safety net is that there is not much of one, so if real estate and the stock market were to collapse, people would face an uncertain future. That outcome would surely lead to unrest and possibly revolt at the leadership.
Plus, there’s Chinas history of warlordism. How secure is the Central Committees’ grip on power?
During the Tiananmen Square “Democracy” movement, the Central Committee finally said “Enough is enough,” and called out the army. When will it happen again? And, if the economic mess gets worse, as it looks to, will the regional commanders respond to Beijings’ call?
Morgan Stanley and BofA seem to be umm — all over this. Sharma’s screeds may have truth in them but also a heapin’ helpin’ of not so sly propaganda. To the extent that it has made me wonder to what degree they may have their filthy hands in it. Pivot to Asia might mean many things.
Sounds like National Total Security State.
And stock markets become strategic targets.
Already, one reads about all kinds of conspiracy theories.
but it rhymes…
nyse was the chinese stock market of its time in 1914
ww one breaks out on a tuesday…the nyse shuts down two days later until november
panama canal open up two weeks later…in august 1914.
ny fed was not open for business yet…nyse opened back up two weeks after ny fed is officially opened…
barschel in germany is accidented so he can’t burp up what he knows about schaeubles party political watergate…a week later when the american stock markets open on “black monday”…naked short positions flood the market…don’t recall an honest review in 1987 of who placed these orders…
change is frightening to those who have recently joined the mammon klub…or those old stale pieces of bread hanging onto power…
the bolsheviks did not remove the czar…it was his fellow nobles…prince georgy was made ruler when the romanovs, having previously lost their clown prince raz-putin to the nobles, now were forced to abdicate as they did on the ides of march…
most despotic power comes from one of three illusions….
we can shoot you…
we can burn your house down…
or
we can drive you to suicide or depression by attacking you in the court of public opinion…
germany is only one percent of global population with five percent of global gdp…basically insignificant if there is no euro for them to control europes 500 million lemmings…with a demographic problem which will reduce them to economic dust in less then 20 years…they will be europes argentina…
20 years from now bangladesh will be the fifth largest country in the globe by population…it is already number two clothing manufacturer…
history rhymes but the world is always changing…
secret ithakan curse…
me and time against any army…
How tightly will all those Bangladeshis be packed? Especially considering a land base shrinking under a rising sea level?
Well . . . that many Bangladeshis will not be denied. Perhaps they will invade Burma ” to save their Rohinga brothers”.
You can bet that this is making American universities very nervous.
The percentage of international students, many of them from China and almost all of them full-pay, has soared in recent years. Their tuition is crucial to balancing the budget at many US colleges. Some of the Chinese students might be from families with enough wealth to afford to send their kids to the US even after a market rout, but many of them are not. The question is, how many of these students will fail to show up for classes in the fall?
I suspect the lines at Disneyland will not be shorter though.
“I pay to wait in line.”
And we don’t have very good answers for China. One of the notorious features of the economy is the lack of reliable data. Even though margin lending is high by US standards, 4.4% before today’s fall, it’s vastly below the amount of gearing in the US stock market before the Great Crash. Value Walk (hat tip Lambert) puts margin debt at 8.5% of free float, which is a troublingly high level. Ruchir Shama, the head of emerging markets and global macro at Morgan Stanley, similarly estimates margin lending at close to 9%, which he calls “the highest in any market in history.” Moreover, there is no way of knowing the degree to which the money that went into stock buys was from borrowings other than margin loans, say by borrowing against real estate. So a big loss in the stock market could lead to later defaults on other loans.
This is confusing. Is the 4.4% margin lending in China the “official” lie and reality is at least twice as much?
Even in an article as grim as this, there are flashes of comedy.
“The plunging stock market is essentially a meat grinder, shredding money meant for buying cars,”
The authorities have “not only failed to stabilize the market, they have actually increased panic levels,” Alex Wong, Hong Kong-based asset-management director at Ample Capital Ltd., which oversees about $129 million, said by phone. “We are reducing exposure, raising cash levels and trying to stay out of the market.”
Damned if you do and damned if you don’t.
I had no idea Chinese stocks were up 72% for the year. With a run like that, who could be surprised that the music is finally getting close to being over. I had expected some kind of crash in the Chinese economy years ago, mostly based on those reports of entire towns being built and empty, but it’s gone on way longer than I thought possible. That’s the funny thing…never underestimate the ability of a bubble, ponzi, or any kind of general delusion to continue. These kinds of systems are far more resilient than most want to believe.
It’s better to accept a small setback now than a large, maybe even lethal, defeat later.
A lesson for those masters of can-kicking.
Before the crash, the market was up more than 150% from about a year ago. After the crashes now the market still some 70-80% higher than a year ago. The market needs to find its new equilibrium.
With Chinese stock market suspensions at 71%, that’s almost like the market not opening.
In Greece, the banks are closed.
Maybe it’s karma. Yahoo is reporting that the NYSE suspended trading of all securities due to technical problems at 11:32 AM this morning.:
http://finance.yahoo.com/news/nyse-temporarily-suspends-trading-securities-155649443.html
Hope it’s just a coding issue.
We here too at NC have had technical issues before.
But these guys have a lot more money to make sure it doesn’t happen to them.
Light chasing light doth light of light beguile.
Heavy handed move by Chinese authorities – bloomberg headline: “china bans stock sales by major shareholders for 6 months”, this on top of halting trading on many individual securities.
And, coincidentally I’m sure, the NYSE has suspended trading as of around noon eastern time…
K A B O O M ! ! ! !
Now if you will excuse me. I have to go say “I told you so.” to a bunch of neo-liberals.
It is just o e of China’s war games against US’s pivot to Asia. A test of market rescue mechanism when a serious meltdown is caused.