Chinese stock market crash

China's Stock Market
China’s Stock Market

Since June 12th the Chinese stock market has fallen by 26% (source), equivalent to roughly $3.2 trillion of market value.

Why?
There’s no definite explanation for why the stock market crashed, some believe it is a result of speculative trading similar to the 1929 crash, others blame foreign investors. However with GDP in China beginning to slow from a century peak of +14.9% annually in 2007 to the +7.42% of 2014 (source), it wouldn’t be a completely inaccurate to deduce that investors are worried about the sustainability of Chinese economic growth, and are demonstrating this anxiety through the stock market.

Government reaction
The Chinese government has reacted to the stock market fall with guns blazing. They’ve temporarily prevented IPOs from being filed, to encourage investment into current companies. Alongside this, state run companies are pumping 120bn yuan into the stock market and the central bank has been mobilised, reducing interest rates to a record low and reducing trading fees.

This reaction from the Government is a result of a couple of different issues at play. Firstly, the Chinese government is trying to restore confidence in their stock market. With a record number of retail investors at 90 million, there are now more investors than communist party members (source). This places particular pressure on the Government, which is facing an increasingly capitalist society, which is challenging its communist policies. Secondly, it is thought that a fall in the stock market will create a wealth effect, with investors feeling less wealthy and reining in consumer spending. Societe Generale believe this crash could take 0.5 to 1% off the real GDP growth of China in the next 12 months (source). This is causing the Chinese Government to considering stimulus packages, as they are anxious to keep economic growth sustainable and high.

What next?
We see in this crash resonating reminders of the 1929 crash, however the main difference here is that a significantly smaller % of the Chinese population own shares, compared to the % of Americans who owned shares during the 1929 crash. Therefore a number of economic commentators have suggested there will be less of an effect on the overall economy, with a worse cash scenario being Chinese economic growth of just +1% to +2% .

Moral Hazard.
However it is important we keep an eye on Moral Hazard. The Chinese government’s reaction to the crash could give investors confidence that the government will intervene whenever there is a crash in the market, creating a ‘too big to fail’ scenario. The Chinese government will need to ensure they have a viable exit strategy after propping up the stock market and that it is clear they won’t be relied upon to intervene every time the market drops. Or we could see an even larger bubble developing much further down the road.

@Breadeconomics

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