YOU WAIT AGES for a crisis and then two come along at once. It’s now all about China and not Greece and the former’s recent stock market price action over just a few days resembles the kind of free-fall we haven’t seen since the worst of the global financial crisis.
I wonder if Nobel prize economics laureate Paul Krugman is smiling right now since he has for quite a few years warned of China facing its “Great Wall” in the form of an economic collapse.
But hold on a moment. For now it’s just falling Chinese stock prices, however precipitous the decline. And let’s not forget that China enjoys a 7% annual GDP growth rate, which is the envy of most finance ministers around the world.
Nevertheless you have to wonder if Mr Krugman’s bold call will be vindicated, since this is the man who predicted with uncanny accuracy the Asian financial crisis of the late 1990s just months before it kicked off.
China’s staggering stock market implosion over the past few weeks bears the hallmarks of the classic 1929-style Wall Street Crash, with euphoria followed by panic and despair.
That infamous collapse heralded the Great Depression, although the exact causal relationship between the Crash and the subsequent economic slump is still a matter of debate among economists: did A (the crash) cause B (the slump) or did it merely anticipate it?
THERE ARE ECHOES of 1929 in what’s happening in China’s stock market: stratospheric price rises in a short period of time, funded by margin lending and a mass of retail investors.
Many of these investors have never owned stock before but were using the magic tool of leverage to climb on to a bandwagon driven by the relentless engine of greed. The latter has been replaced, for the time being at least, with its bedfellow, fear.
Last Wednesday saw more panic selling in the Chinese equity markets, with around a third of the counters in Shanghai and Shenzhen now suspended from trading. Both markets are down about 30% from the peaks they hit in June and confidence is in shreds.
China’s staggering stock market implosion over the past few weeks bears the hallmarks of the classic 1929-style Wall Street Crash
In response to the rout the Chinese financial authorities have come up with desperate measures in a bid to push markets back up to key support levels. The announcement made last Wednesday by the People’s Bank of China that it would provide market liquidity via any means, including collateralised lending and bond issuance, had echoes of ECB president Mario Draghi’s promise at the height of the eurozone debt market crisis to do “whatever it takes” to stabilise markets.
Those words had the intended effect and brought stability to the eurozone debt markets, in effect ending the crisis. Will the same thing happen in the Chinese equity markets in response to the PBOC’s intervention? I’m not sure. Unlike bond markets, which are largely in the hands of institutional investors, a critical chunk of China’s listed equity is in the hands of retail buyers, who are easily infected by panic. Halting margin calls may ease the turmoil, but should the PBOC push markets back up many retail investors might simply see it as an opportunity to minimise losses and rush for the exits.
I have written about the classic capitulation of the Kindleberger-Minsky model of financial crisis in this column before.
There are five stages to this model: stage one involves a displacement, such as a war, the introduction of new technology or financial deregulation. Then comes a boom, such as we have seen in Asia since the region’s financial crisis. Stage three involves leveraged growth, based on underlying euphoria. Stage four involves industry insiders selling, before speculators rush for the exits in stage five, which is characterised by panic and revulsion.
It’s not hard to argue we’ve seen all these stages in China and that we are now at stage five.
TO BE SURE, China’s financial authorities have vast firepower at their disposal to reverse this collapse: they have a variety of weapons in addition to those mentioned above. Reducing bank reserve requirements; cutting interest rates where there is still a lot of meat left to slice at; and even utilising the country’s colossal foreign exchange reserves to make direct equity purchases are all in the arsenal.
The paramount concern for China’s leaders is averting social unrest. It’s long been received wisdom that this is a threat in China should GDP growth fall below 7% and stay there for a prolonged period. No-one mentioned a stock market collapse as the potential propagator of social agitation, although perhaps as the Chinese stock markets pushed into three-fold gain territory in barely a year it should have been flagged.
If Krugman is right, then we will shortly be witnessing China’s equivalent of the Great Depression unfold. That has huge implications for global financial markets, since China has been the world’s growth engine for a long time, contributing 23% to global GDP growth from 2000 to 2013.
But to stay with the topic of China: will this usher in the logical conclusion of the tenet offered in so-called “modernisation theory?”
The theory holds that prolonged economic prosperity brings with it demands for greater political freedom. Could crisis in China bring demands for the replacement of authoritarianism with democracy? That won’t be music to the ears of the Chinese government, but it’s something that investors need to bear firmly in mind.
