China is experiencing another stock market crash

While most people and economists are focusing their concern on Greece, a potentially much more important and influential crisis is developing on the other side of the world, in China. Some economists are even comparing it with the 1929 crisis which happened in the United States and started the economic catastrophe of the Great Depression. Indeed, there are a lot of similarities between the two situations. 

The main reasons for the crisis occurring in China are believed to have been mainly greed, buying stocks on credit and mistakes from the administration managing the Chinese stock market. The crisis started in mid-June and triggered a significant reduction in share prices listed in Shanghai and Shenzen.

In addition, this had a negative impact on the trading securities of Chinese companies in Hong Kong. Within three weeks, the main Chinese stock indices lost almost one third of their value. China’s stock market capitalisation has shrunk by approximately three billion dollars, which is equivalent to Brazil’s GDP. Although bursting the speculative Chinese stock market bubble has been anticipated for a few weeks, its actual occurrence has left everyone in disbelief.

The boom on the Chinese stock market peaked quite unexpectedly. It began in November 2014 when the Chinese Central Bank suddenly cut interest rates. The violent boom served to increase the Chinese index in the fourth quarter of last year. CSI300 index has gained 40 percent since then (52 percent over the year 2014) and in the first days of 2015 it underwent a correction which turned out to be an opportunity to buy cheaper shares. 

At the peak of the bull market, in the first half of June 2015, the index was 126 percent higher than it was at the moment when it started its upward incline. The increase in stock prices of small and medium-sized companies was much higher than the growth of the CSI300 index, which includes shares of the major companies. At its peak, the market capitalization of Chinese stock exchanges reached 11.5 billion dollars and it was higher than Chinese GDP. High returns from the stock market attracted not only professional speculators, but above all lay investors from the Chinese society. Over the last year, the number of brokerage accounts in China grew by nearly 30 percent, reaching 68 million at the end of May 2015.

In the last weeks of June, the Chinese retail investors accounted for up to 85-90 percent of the participation in trade exchange, an incredibly high statistic. Small investors were investing in shares not only with owned funds, but also through various types of loans, of both an official and more informal nature.

At the end of May brokerage loans to purchase shares were worth 322 billion dollars, five times higher than a year earlier. It must also be added that the money was borrowed even from family and bank loans. Probably people would have invested even further had they had someone to whom to sell the shares at a higher price than purchased.

Unfortunately willing buyers were suddenly sparse and panic started to spread as in a typical crash. In less than a month the Shanghai Stock Exchange Composite Index dropped by 30 percent in value. As a consequence, at the beginning of July almost 940 companies, more than a third, had suspended trading on China’s two main indices. Despite this, the crisis in China remains a marginal issue in the shadow of the euro crisis fostered by the demise of the economy in Greece. Nevertheless, it is worth to consider if we should be worried about it and whether the crisis on China’s stock market may be similar to that of 1926 in the USA.

Some similarities cover that:

Both these booms, are in part explained by extremely rapid credit growth, borrowing money and investment margins;

 As in the 1920s in America, China’s stock market boom has risen in tandem with an equally speculative real estate bubble;

Similarity in macroeconomics backdrop – the same as in the 1920’s in the USA China witnessed a fast growth of industrial sectors that inspired households to invest in them and rural workers continue to emigrate to the cities in vast numbers in the hope of finding a more prosperous life in fast-growing industrial sectors;

There are warning signs of a slowdown in China, similar to those that preceded the 1929 crash combined with the effect of depressed commodity prices, a virtual hiatus in global trade growth and a decline in consumption.

On the other hand, there are pointers which show that an actual crisis in China’s market stock is not as dangerous as the US crisis in 1926. This crash, which we are presently witnessing in China, will not have the same impact on global economy as the universal shock generated by the American stock market crash. 

The crucial difference is that China is still mainly a planned and centrally-controlled economy which has so far defied the usual rules of economics. China is a state-run economy, where the biggest banks, factories, and businesses are fully owned by the government, not individuals.

To a much larger degree than we can imagine in Europe, events in China are dictated (sometimes indirectly) by the government. The Chinese authorities have a predominant influence on the economy, much more so than was the case of the liberal USA government. The recent collapse even belies the fact that the Chinese government can have every solution trying to act as if everything is under control. The attempts of cooling the market by floating initial public offers and the introduction of other new companies to trade failed on all fronts. Maybe, this points towards the first step towards the liberalisation of the Chinese market. 

The other argument is that the real cause of the financial crisis is not due to the crash itself, but more so to a collapsing banking sector. So far the Chinese banks still remain in the shadows, thus there are no signs of a factual economic crisis. 

Another difference between the drops in China’s financial sector compared to that suffered by America in 1926 is the different focus in terms of approach. In America, roughly 50% of the population owned stocks, either individually or through mutual funds, retirement plans, and pension funds. By comparison, the number of investors in China is less than 10%. Most Chinese accumulate wealth through real estate and traditional savings accounts because the financial industry (mutual funds and managed retirement plans) is still rather rudimentary. 

Apart from that, China has curbed real estate growth. A few years ago, Chinese real estate prices reached a level which concerned the authorities, causing them to implement measures to curb real estate price growth. In response, real estate sales have slowed down while new construction has declined sharply, and banks have become increasingly cautious about lending to developers and homebuyers. Housing prices fell in June for the second month in a row, as evidenced by two recent surveys. Individual investors were ripe for other investment opportunities.

Furthermore, the most essential fact in favour of mitigating the crisis in China is the Chinese government’s restriction on foreign stock ownership – since less than 2% of the stock market is owned by foreigners. This means the investment is restricted to Chinese individuals who own more than 80% of all Chinese stocks. 

The facts mentioned above prove that we will not be experiencing another significant crisis like that of 1926 in the USA. This does not mean that we do not have to worry about the situation on the Chinese stock market. Although the Chinese economy will not have such an effect on the global financial situation as the American one did, China is one of the biggest exporters in the world, with exports reaching to every part of the globe.

Thus, the sudden crisis in China may influence consumption and standards of living in other countries. To conclude, in Europe we are much too focused on the euro currency buffeted with the demise of the Greek economy and tend to forget the importance of China’s crisis which seems to go under the radar screens of the media.

Anna Halas is a research assistant in PKF Malta, an audit and business advisory firm