Chinese Stocks Plummet Despite Beijing Intervention

The stock markets in the People’s Republic of China, an allegedly communist state, have been in free fall since mid-June. They have lost about 30% of their value since then, wiping out the yuan equivalent of $3 trillion. Since these are largely paper losses, the direct impact on the real economy is miniscule. However, the psychological effects may reduce demand. Consequently, the Beijing regime has intervened in a variety of ways to stabilize prices. At first glance, not only have these measures failed to halt the slide, but also they may have increased downward momentum.

The Shanghai Composite Index fell 8% when trading opened a few hours ago, and this was after the government implemented measures to support prices. Reuters noted that other exchanges were also lower, “The ChiNext growth board .CHINEXTC, home to some of China’s giddiest small-cap valuations, fell 5.1 percent.” There was a pause in the drop on Monday when government intervention was first in play, but “After a brief pause in the slide on Monday, the CSI300 index, CSI300 of the largest listed companies in Shanghai and Shenzhen [sic] ended down 1.8 percent on Tuesday, while the Shanghai Composite Index lost 1.3 percent.” As a result over 1,300 firms have halted trading altogether.

Bloomberg reported, “Among the latest support measures, the China Financial Futures Exchange raised margin requirements for shorting contracts on the small-cap CSI 500 Index. China Securities Finance Corp. said it will buy more shares of small- and mid-cap companies, while people familiar with the matter said the government agency is seeking at least 500 billion yuan in liquidity to support equities. The government also ordered state-owned firms not to cut holdings in their listed companies.” Initial Public Offerings, with their almost-guaranteed profits, have been halted.

However, 80-85% of the Chinese market is composed of 90 million retail investors, unsophisticated participants who tend to follow what their friends and family are doing (and incidentally a larger constituency than the Chinese Communist Party). According to the same Reuters report, “‘Where is the promised 120 billion yuan?’ asked one retail investor from Hangzhou, who gave his surname as Liu. ‘It’s all going to blue chips. Don’t they know that retail investors are all trapped in the small caps? My stocks opened up 10 percent but closed down the (10 percent) limit!’”

This is not quite the disaster that it appears at first, at least not yet. The stock market makes up just 5% of the economic activity in China, so a 30% drop there shaves just over 1.6% from GDP. Chinese economic growth rates can absorb that kind of loss. Moreover, the SCI was up 150% from June 2014 to June 2015. A correction was definitely in order. Most of the increase stemmed from retail investors discovering the power of margin and leverage. It’s 1929 in China’s stock market.

Where this becomes a real problem is the extent to which the common Chinese citizen loses faith in the idea of investment. Communist in name only (and in repressive measures against the Party’s enemies), China needs retail investors to believe in the system. Losing one’s life savings is not the best way to reinforce such beliefs.

Keeping faith in the markets is now the goal. The Financial Times reported, “Even China’s censors were not left out of the effort. One local reporter, who did not want to be named, said the government had banned local media from using the terms ‘equity disaster’ and ‘rescue the market’ in their reports on the stock market.”

Chairman Mao would have solved this easily enough. He would have put the market up against the wall and had it shot. If the current Beijing government isn’t careful, the communists might come back.