 "Six questions that help understand the Chinese stock market crash")
The world has been on the edge over the last few days, first with the Greek referendum and then with the correction in China’s stock market threatening to send the financial world into a tailspin. The Greek referendum came and went, and the markets responded with unexpected calmness but the meltdown in Chinese stock and property markets is another game altogether. After all Greece accounts for only 0.38% of the global economy, while China is a super economy at 16%. Let’s find out what’s happening in China and how much it matters to the rest of the world.
What led to the rise of the Chinese markets?
The Chinese markets have grown at a phenomenal 140% between June 12, 2014 and June 12, 2015. This was a result of the loosening of monetary policy by the Chinese central bank. The Chinese government clamped down on lending by banks for investments in real estate (where a slowdown was already visible) while a simultaneous relaxation of laws regulating the stock markets made it easier for both companies and investors to offer and invest in shares.
There has been an IPO boom on the stock market as a result and everybody in China thought it fit to become an investor. Taxi drivers, students, janitors, pensioners and the like joined the share investment bandwagon which further gave a push to the stock market. More than 14% of the Chinese population is now trading on the Shanghai and Shenzhen stock markets and they represent more than 80% of trading that takes place in these markets. One of the most interesting cases was about a farmer who gave up farming to trade in stocks as he found it more lucrative.
What is happening now?
The Chinese markets hit a peak on June 12, 2015 and have been falling since. In less than a month since then, they have lost more than 30% of their value. More than $3 trillion worth of value has been wiped out. William Pesek had warned on 22 June that the market bubble had grown to unsustainable proportions. Analysts pointed out that this growth over the last year wasn’t a result of strong fundamentals. They said this was actually a period when the Chinese economy had grown at the slowest rate in a long time. As the Chinese markets entered a bear phase they predicted that nobody knew when they would bottom out.
What about margin calls?
Individual investors’ investments in the Chinese markets have been fuelled by borrowing from a broker to buy securities; otherwise known as margin trading. Under this system, the investor puts in a small amount to buy a stock and the rest of the funding for the trade comes by way of a loan. If the stock price falls, the broker can make a demand for more cash or collateral from the investor. This is known as a margin call. As investors got easy access to borrow funds, this led to a boom in the markets leading to a trebling of margin debt and when the regulators started tightening the screws, share prices fell, triggering more margin calls by brokers. If the market falls further, margin calls will create more trouble as investors may need to liquidate other assets to generate cash.
What about investors?
Foreigners own just 1 to 1.5% of Chinese shares and those that do are not allowed to sell short or can sell short only a tiny percentage of their holdings. While a 30% decline after a 140% leaves Chinese markets 68% higher than in June 2014, which is still impressive as long as the investor is not leveraged. The trader who depends on margin finance to buy shares would be in trouble. Also, stocks are just 15-20% of total investments by the Chinese households.
How has the Chinese government responded?
The Chinese government tried to slow down the slump and took a series of steps. It cut down lending rates and also the cash reserve ratio to help maintain liquidity in the markets. It also allowed government owned pension funds to invest in the stock markets hoping that it would bolster markets. Curbs were introduced on new share issues, and brokerages and fund managers were enlisted to buy huge amounts of shares with the backing of the China Securities Finance Corporation.
Beyond that the Chinese state has taken to blaming short sellers and foreign conspirators as well. Morgan Stanley came in for criticism along with “foreign devils” and “foreign crocodiles” for having caused this fall.
What next?
Owing to the limited exposure, foreign investors are not in much trouble as the Chinese stock market bubble bursts but thanks to panic selling by the Chinese themselves, commodity prices are starting to take a hit. This will have an effect on those economies which are large exporters of these commodities. We may not see a contagion fall in other international markets, but the effect of this fall will be felt in other areas. There will be a reduction in consumption as leveraged traders will be hit by losses and investors would be seeing their profits shrink. Some investors might cut consumption when the value of stock holdings gets wiped out while the liability will continue to remain.
Windfall gains from the stock market along with high disposable income and a strong yuan spurred the Chinese tourists to spend a record $165 billion on overseas travel during 2014, a 28% growth over 2013. The Chinese consumers also account for 12% of global luxury goods sale. These will face an impact as the Chinese markets crash.
Twitter: @bhayankur
Read more from our special coverage on "CHINA MARKET MELTDOWN"
What led to the rise of the Chinese markets?
The Chinese markets have grown at a phenomenal 140% between June 12, 2014 and June 12, 2015. This was a result of the loosening of monetary policy by the Chinese central bank. The Chinese government clamped down on lending by banks for investments in real estate (where a slowdown was already visible) while a simultaneous relaxation of laws regulating the stock markets made it easier for both companies and investors to offer and invest in shares.
There has been an IPO boom on the stock market as a result and everybody in China thought it fit to become an investor. Taxi drivers, students, janitors, pensioners and the like joined the share investment bandwagon which further gave a push to the stock market. More than 14% of the Chinese population is now trading on the Shanghai and Shenzhen stock markets and they represent more than 80% of trading that takes place in these markets. One of the most interesting cases was about a farmer who gave up farming to trade in stocks as he found it more lucrative.
What is happening now?
The Chinese markets hit a peak on June 12, 2015 and have been falling since. In less than a month since then, they have lost more than 30% of their value. More than $3 trillion worth of value has been wiped out. William Pesek had warned on 22 June that the market bubble had grown to unsustainable proportions. Analysts pointed out that this growth over the last year wasn’t a result of strong fundamentals. They said this was actually a period when the Chinese economy had grown at the slowest rate in a long time. As the Chinese markets entered a bear phase they predicted that nobody knew when they would bottom out.
What about margin calls?
Individual investors’ investments in the Chinese markets have been fuelled by borrowing from a broker to buy securities; otherwise known as margin trading. Under this system, the investor puts in a small amount to buy a stock and the rest of the funding for the trade comes by way of a loan. If the stock price falls, the broker can make a demand for more cash or collateral from the investor. This is known as a margin call. As investors got easy access to borrow funds, this led to a boom in the markets leading to a trebling of margin debt and when the regulators started tightening the screws, share prices fell, triggering more margin calls by brokers. If the market falls further, margin calls will create more trouble as investors may need to liquidate other assets to generate cash.
What about investors?
Foreigners own just 1 to 1.5% of Chinese shares and those that do are not allowed to sell short or can sell short only a tiny percentage of their holdings. While a 30% decline after a 140% leaves Chinese markets 68% higher than in June 2014, which is still impressive as long as the investor is not leveraged. The trader who depends on margin finance to buy shares would be in trouble. Also, stocks are just 15-20% of total investments by the Chinese households.
How has the Chinese government responded?
The Chinese government tried to slow down the slump and took a series of steps. It cut down lending rates and also the cash reserve ratio to help maintain liquidity in the markets. It also allowed government owned pension funds to invest in the stock markets hoping that it would bolster markets. Curbs were introduced on new share issues, and brokerages and fund managers were enlisted to buy huge amounts of shares with the backing of the China Securities Finance Corporation.
Beyond that the Chinese state has taken to blaming short sellers and foreign conspirators as well. Morgan Stanley came in for criticism along with “foreign devils” and “foreign crocodiles” for having caused this fall.
What next?
Owing to the limited exposure, foreign investors are not in much trouble as the Chinese stock market bubble bursts but thanks to panic selling by the Chinese themselves, commodity prices are starting to take a hit. This will have an effect on those economies which are large exporters of these commodities. We may not see a contagion fall in other international markets, but the effect of this fall will be felt in other areas. There will be a reduction in consumption as leveraged traders will be hit by losses and investors would be seeing their profits shrink. Some investors might cut consumption when the value of stock holdings gets wiped out while the liability will continue to remain.
Windfall gains from the stock market along with high disposable income and a strong yuan spurred the Chinese tourists to spend a record $165 billion on overseas travel during 2014, a 28% growth over 2013. The Chinese consumers also account for 12% of global luxury goods sale. These will face an impact as the Chinese markets crash.
Twitter: @bhayankur