“Beijing is scrambling to control the chaos”

A report notes the ongoing collapse of the Chinese stock market and how whatever safety net is too late to save it, “China’s stock-market bubble has burst, and Beijing is scrambling to control the chaos. It’s better to stop bubbles from forming in the first place, but Beijing failed to act — perhaps because the rising markets were a rare bright spot in a period of relative economic malaise. Now, with millions of fortunes already destroyed, continuing to do nothing might be the best approach. But that hasn’t stopped the government from diving in. The crash in Chinese share prices is a symptom of a market that is serving new strata of society as it develops, just like the American bourses during the dotcom boom”.

He makes the point that it was supply and demand rather than the fundamentals of the companies that were driving up prices, “even though the last bubble and crash occurred less than a decade ago. In 2008, the Shanghai market plunged spectacularly after increasing its value five times over in the previous two years. Once the global financial crisis subsided, however, it didn’t take long for investors to pour their money back in. And in recent months, they bet that prices in the Shanghai marketand others — would continue to climb indefinitely, borrowing billions to trade on the margin. One problem is that these are not the same investors as in 2008. For the past several years, China has been the world’s primary growth market for online trading accounts. Tens of millions of people have bought stocks for the first time and discovered the wonders of margin trading. Many are members of China’s burgeoning middle class, but that doesn’t mean they’re sophisticated investors; the majority may not even have finished high school. Now, with the markets down roughly 30 percent, their heavily leveraged positions have started to crumble”.

Pointedly he writes that “The government is understandably concerned, as more than three trillion dollars in wealth on paper, which didn’t even exist last spring, has already disappeared. But it’s not taking the right steps to salvage the situation — nor does it necessarily have to take any steps at all. So far, Beijing has placed a moratorium on initial public offerings, apparently in the belief that doing so will discourage churn (and thus more selling) in the markets. In reality, the move just protects existing investors — and the bloated companies they own — at the expense of businesses raising money to expand their operations. The Chinese government is also putting together a stabilization fund, including contributions from 21 brokerage firms, to prop up blue-chip shares”.

Interestingly he argues that “it’s not even obvious that the markets are still substantially overvalued, so none of these measures may even be necessary. On the Shanghai market, price-to-earning ratios have come down from a peak in the forties (for the median share) to the upper teens, which is somewhat elevated but not crazy for an emerging economy in East Asia. In Shenzhen, the ratio was around 45 at the time of this writing. But given the higher concentration of manufacturers on the southerly exchange, this higher figure could signify lower earnings for exporters — possibly a temporary phenomenon — as well as inflated prices. If shares are nearing prices that reflect the underlying values of the companies, rather than frothy demand for stocks, then doing something may be more dangerous than doing nothing. Beijing is setting a risky precedent by acting as a backstop not just for financial stability but also for the market capitalization of publicly traded companies. In the future, with no incentive for caution, investors may adopt even riskier behavior than the kind that has landed them in their current multi-trillion-dollar hole“.

This was seen spectularly in the Eurozone, Ireland and the UK had huge liabilities and yet where brought into the public balance sheet. The real lesson was Iceland who refused to prop up the banks and let them go bust only protecting the money of people over investors. The result was enormous pain for Icelanders in the short term but long term benefits.

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One Response to ““Beijing is scrambling to control the chaos””

  1. Pakistan, friendly with China | Order and Tradition Says:

    […] how likely this is to take place now that the Chinese economy is imploding remains to be seen. It could be just another unmet pledge to […]

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