China’s “engineered” market correction raises global concerns
This was an engineered drop. The Chinese government has become increasingly concerned about levels of investment in its economy or, more accurately, the sheer amount of money that is chasing projects. State firms with limitless access to subsidized capital from state banks have used that access to launch thousands of nonprofitable firms. This glut in “investment” money drives up the cost of commodities and adds industrial capacity without actually producing anything of much use, making life more difficult for the average Chinese and unduly harming relations with foreign powers that face a glut of otherwise noncompetitive Chinese goods.
This penchant for overinvestment has now spread to the stock market in two ways. First, the same politically connected government officials who started dud companies are taking out loans to buy shares, or are using shares they already hold as collateral for new loans. Second, ordinary Chinese citizens have started borrowing — sometimes against their homes — in order to play the market. In January, the number of total traders on the Chinese exchanges grew by 1.38 million, an increase of 134 percent from a month earlier, while stock turnover was up 700 percent from a year earlier.
The net result is an absurd stock surge with no basis in fundamentals. At present, some Chinese banks now have price-to-earnings ratios higher than financial behemoths such as Deutsche Bank and Chase, despite deplorable management and a history of highly questionable lending policies.
For the past few months, the government has been working to drive down this speculative investing. On Feb. 26, China’s State Council launched a new “special task force”…Its express goal is to get the Chinese domestic security brokers to lay off such speculative decision-making, while also putting a crimp in the source of the subsidized capital. Day one started by the script, and Beijing is likely quite pleased with the way things are going (or at least it was until its actions unintentionally triggered a global meltdown).
It is not reassuring to see who some of these Shanghai “investors” have been. Some remind us of those stories from 1999 of barbers on Cape Cod who spent much of their time day-trading and dispensing wisdom on internet stocks. Reuters:
Worried Chinese investors flocked to brokerages on Wednesday, even as Shanghai’s main index (^SSEC – news) rose more than 4 percent in late session trade after opening 1.34 percent lower. “Yesterday, I lost over 10,000 yuan ($1,290),” said a 37-year-old former company driver in Shanghai surnamed Li. “If this trend continues, I’ll sell all my shares at the end of the year.”
It is difficult to know where this is heading, despite the Shanghai market’s stabilizing today. It was not long ago that no one cared about the Shanghai market, as we wrote two years ago. Now that apparently has all changed, as concerns about China’s poorly regulated financial sector and its “internet bubble” in bank IPO valuations meet global concerns about liquidity and China/India growth. We’ll just have to see how this all settles out.