The Shanghai stock exchange hit a seven-year high on June 12. Shortly afterwards, by July 8, it lost 32 percent of its value – over $3 trillion (R38 trillion) was simply wiped out in less than four weeks. It stabilised and regained about 15 percent of its value by July 21, but this week it has started to slide again.
The explanation behind such a sudden crash lies in the rise rather than the fall of the stock market. Having remained relatively stable throughout 2014, the Shanghai composite index (an index that measures the overall value of the Shanghai Stock Exchange) shot up from 2 060 points in July 2014 to 5 166 in June 2015 – a 150 percent increase in 11 months. Over the same period the New York Stock Exchange only grew by 1.2 percent.
The sudden growth in the value of stocks was primarily due to the increasing practice of margin lending, which allows people to borrow money to invest in the stock market – much like banks issue mortgage loans to invest in property. Official margin lending grew from 403 billion yuan renminbi (R828bn) in June 2014 to 2.3 trillion yuan in June 2015. In addition, unofficial margin lending is estimated to contribute between 500bn yuan and 1 trillion yuan.
When the stock market crashes – just as when the property market does – investors are unable to pay back their loans and the economy faces a shortage in liquidity.
Chaos is never left alone for long in China and on June 27 the Chinese government began to implement a series of interventions to halt the market’s slide. They began by decreasing interest rates to encourage borrowing and increase the money available to buy shares. When this had little effect they allowed the state pension fund to invest up to 30 percent of its portfolio in stocks and a week later they passed regulation that gave greater freedom to insurers to invest in the stock market.
Blunt tools
A six-month ban was placed on share sales by large shareholders and initial public offerings (IPOs) – the initial sale of shares when a company first lists on the stock exchange – were suspended. These measures were all blunt tools to try and increase the demand for shares and decrease supply. Until early this week they appeared to work but on Monday the Shanghai stock exchange fell by 8.5 percent – its largest drop in one day since 2007.
Does this matter? Not really. Only 8.8 percent of Chinese households participate in the stock market, compared with more than 30 percent in the US and other western economies.
China’s stock markets (the Shanghai and Shenzhen exchanges) have little connection to the real economy. In the time that shares more than doubled their value, China’s gross domestic product only grew by 7 percent. The listings are dominated by state industry rather than private companies. Chinese shares rarely pay dividends and share trades are mostly speculative rather than long-term investments based on the value of the company. Regulation and access to credit are stronger determinants of stock market value than economic fundamentals such as production and consumption levels.
Consumer spending was barely affected when the stock exchange grew by 150 percent, and it won’t be affected by the subsequent drop. Investment into China’s stock exchanges is highly restricted to foreign traders and contagion of China share volatility to global markets is unlikely.
What the fluctuations have shown though, is that the Chinese government can and will intervene in the market if necessary. But in terms of global financial stability, their stock exchange volatility is nothing more than a storm in a teacup.
* Pierre Heistein is the convener of UCT’s Applied Economics for Smart Decision Making course. Follow him on Twitter @PierreHeistein
Business Report