Chinese Howevers (2)

The Chinese economy faces a lack of internal demand. When the current growth phase began, everyone in China was poor. For many years, it relied on growing demand for its exports, but since the GFC that growth has faltered.

The Chinese government is now encouraging its middle classes to get into the share market, so the regular income and wealth effects will encourage consumption increasing the demand for production.

However, the share market fall will shake confidence and act as a break on consumer demand.

Government Action
President Xi and his technocrats believed that high stock values would allow highly indebted companies to sell shares at a high price and use the proceeds to pay off debt at a low cast.

The government is taking actions to prop up the market. The People’s Daily claimed, "We have the conditions, the ability and the confidence to preserve stockmarket stability”. Interest rates have been cut. Central-bank funded share-buying schemes have been implemented. Initial Public Offerings have been cancelled. Short selling has been limited. Rules for pension funds and the social security funds have been changed to allow more investment in stocks.

State-owned companies and controlling shareholders have been ordered not to sell their shares. Rules changed so investors can use their houses as collateral to borrow money to buy stocks. A state-owned securities financing company has lent $42 billion brokerages so they could purchase blue-chip shares.

Trading in 90% of share has been suspended, either at the request of the companies themselves, or compulsorily because prices fell more than 10% in a day.

The actions have had an effect, as share prices have rallied.

However, government attempts to stand against the tide of the market usually fail in the long term.

Economic Growth
The growth of the Chinese economy has been slowing over the last couple of years.

However, China still has enormous potential further growth.

The government channelled production in to infrastructure but that is no longer so effective. China does not need anymore “ghost cities”. A “One Belt, One Road” initiative is encouraging infrastructure to connect China with the Middle East, and hence to Africa and Europe.

However, whereas companies in the US and Europe rely on equity funding, Chinese companies have expanded using bank debt rather than equity. This means that the share market is far less important than in the West. This means that the impact on the real economy will be much less. The share market crash is unlikely to trigger a major depression in China.

However, the Chinese economy is a state controlled economy. History shows that governments are not clever enough to fully control their economy. The Soviet Union collapsed when the economic contradictions got to great. China has the same contradictions, so it will eventually fall apart too.

China has a debt-based economy. Total debt is $30 trillion. Government debt is equivalent to 300% of annual GDP. It make take a long time, but this will eventually catch up on it.

Chinese Howevers (1)

The financial media have now switched their attention to the Chinese economy. Here is some background information. There are a lot of “howevers” that are usually missed.

Between 2005 and 2007, Chinese stocks rose nearly 500%. In 2008, the market crashed, losing 73% of its value.

However, long-term investors in the share market have experienced ups and downs are still will ahead.

In the 12 months leading up to the peak of the recent rally stocks gained about 150%. Now, they are down by about one-third.

However, shares are still 80% up on a year ago.

Chinese investors have lost more about $3.4 trillion in equity value from the markets mid-June peak.

However, they gained about $6 trillion earlier in the year. Insiders with good information have done really well.

The losers are those who got into the market in the last few months. More than 40 million accounts were opened between June 2014 and May 2015. Those who were late to the party will be feeling pain.

Chinese regulators have relaxed strict limits on buying stocks with borrowed money. As a result, the volume of "margin trading," By the time the stock market reached its peak in June, people had bought 2.2 trillion yuan ($350 billion) of mainland stocks with borrowed money.

However, this financing is not a systemic risk; it is just about 1.5% of total assets in the banking system.

Poor Alternatives

Bank deposits in Chinese banks of $2 trillion, which is twice GDP. About 15,000 per person. People need savings to pay for health care and their retirement. These are not funded by the state in China.

The Chinese government has always kept interest rates low to make it easy for businesses to expand. They are being subsidised by people with money in the bank, who get a poor return on their savings.

Some Chinese have shifted their money to the share market to get a better return than they can get from the bank. This switch is understandable, as up till now it has looked like easy money.

The Government has encouraged the share market boom. Some investors call it a “state bull market” or the “Uncle Xi Bull Market”. Some believed that the government was guaranteeing the shares would go up. A People’s Daily editorial in May, shortly before the market peaked, predicted that the good times were just beginning. This is why the government is working so hard to keep the bubble from popping.

Property has been the main source of wealth for the Chinese middle and upper classes. Selling land to property developers has also been a primary source of funding for most city and village governments, as they do not have authority to levy their own taxes. China's property market has been in a slump due to a slowing economy and excess inventory for a while now, so many people are now seeing the share market a better investment.

Small Investors
In total, there are now more than 90 million stock traders in China, which is more members of the Communist Party.

However, this is only 5 percent of the population, so it is relatively small.

China has a workforce that is rapidly becoming more educated and urbanized. Ordinary people discovered the idea of trading stocks with borrowed money.

31% of university students have invested in the share market, with three quarter are using money borrowed from their parents. Two-thirds of Chinese investors haven’t completed high school. Even Chinese farmers are buying stocks.

However, the stockmarket still plays a surprisingly small role in China. Most business activity is financed by debt, not equity. The value of shares available for trading is only a third of GDP, compared with more than 100% in developed economies. Less than 15% of household financial assets are invested in the stockmarket.

Foreign hedge fund investors have made some huge sales on the Chinese share market.

This leads some Chinese investors to see the falling prices as a Western attack on China.