Dear Mr. Know-It-All,
Can you explain to me, in simple terms, what happened to China’s stock market earlier in the month? – Jordan Gecko
Put simply: the stock market crashed, and the CCP used every dirty trick in the book to try and save it.
You can blame two interrelated things: A hugely overvalued stock market, and what’s called “margin financing,” or using borrowed money to buy securities. Here’s how it works: An investor borrows money from a broker to buy stocks. He puts down a deposit—the margin—as collateral. If the investor’s chosen stocks plunge, the broker issues a “margin call” and the investor has to pump in more money to cover those losses, or lose his stock. Basically if you do well, you do very well. If you lose, you lose very big. And if an unexpected margin call comes in, the effect can snowball and crash a market.
Why does it matter for China? Well, on the mainland this form of financing was authorized in 2010. By 2013 the practice was open to all comers, rich or poor. A disproportionate amount of China’s stock markets—80-90 percent of daily turnover—is formed by domestic “retail investors,” speculating members of the public, as opposed to big money institutions. These are the investors who piled in to boost the market. Despite a slowing Chinese economy, share prices rose 150 percent in the last year. And at its peak, margin financing reached RMB2.2 trillion—a ridiculously high 3.5 percent of China’s GDP. It was a huge bubble, and bubbles only do one thing: burst.
Problems arose when prices began to fall and the margin calls came in. Scared of the stock slide, the Chinese central bank slashed interest rates to pump more money into the economy—standard cooling measures. It did nothing, and so the government ordered brokerages to buy shares to buoy up the ailing market, and pledge not to sell their own stock.
But prices kept dropping, falling by 30 percent and wiping out an incomprehensible US$3.5 trillion: that’s more than the Indian economy. Among a raft of other measures China’s regulators decided that the best way to stop the market from plummeting was to make it easier to borrow money to buy shares, and it waived regulations designed to protect investors: It even allowed people to put up their own homes as collateral for loans. Thankfully, without confidence in the market, the public stayed away.