WASHINGTON – There is no way to tell which way the Shanghai Stock Market is headed. However, it is clear that the July 27 8.5% loss is not just an ugly day in a period of unusual volatility that will eventually come to an end.
A bad day in Shanghai
The fact is that this collapse, the worst one day decline in many years, took place despite highly publicized and very costly ($ 200 billion) government-led counter measures aimed at stabilizing the markets, after a massive rout in early July.
Counter measures
The Beijing authorities watched (probably in horror) a precipitous share prices decline, day after day. They got really worried that a true stock market collapse would ruin millions of retail investors, this way creating a political problem for the national leadership.
And so they rapidly concocted a series of massive interventions to support share prices. They suspended trading. They ordered brokerage houses to buy selected stocks. They made public funds available to execute these trades.
And, sure enough, the $ 200 billion medication worked, at least for a while. For a few days the markets calmed down. On account of the government administered shock therapy, share prices stabilized. In fact, there was some recovery from the huge dip that had taken place in early July.
No real confidence
But on Monday there has been another major collapse, despite the massive intervention aimed at restoring investors’ confidence. And this is truly worrisome, because it means that millions of Chinese investors deep down do not believe that the government has either the ability or the staying power to stabilize the markets, this way saving their investments.
That said, despite this set back, the Beijing government cannot stop intervening. It simply cannot take a chance and allow a market led by millions of scared investors who would love to run for the exit to find its natural bottom. This bottom may be much, much lower then the lows experienced in early July.
What’s really going on?
And this is only half the story. Forget for a moment about manipulated and therefore meaningless share prices. The fact is that most of China’s economy is manipulated. Therefore, it is next to impossible to determine its real health conditions, in the midst of signs that indicate a slow down.
Unfortunately, many Western observers keep forgetting that a large chunk of China’s economy is controlled by the state through State Owned Enterprises (SOEs), always funded by state controlled Banks. These large corporations do not follow market rules as we understand them. You can rest assured that government appointed managers will hide losses, while highlighting bright prospects. You see, the government cannot fail.
What we know
Still, despite this fog, we know a few things, none of them reassuring. We know that, thanks to an ill-advised gigantic stimulus plan aimed at facing the 2008 international financial crisis, in the last few years there has been an unprecedented, in fact grotesque, overbuilding of “everything” in China.
We also know that, in order to support its gigantic construction projects, China added an enormous amount of capacity to every industrial sector supporting it: steel, cement, glass, copper, appliances, furniture, and so on. Taken together, these sectors amount to anywhere between 25 and 30% of GDP.
We know that, on account of this construction frenzy, overall supply of commercial and residential properties now vastly exceeds demand. There are way too many vacant villas, apartments and half empty shopping malls.
As a result of this property glut, construction –the main driver of China’s economic growth– had to slow down, dragging down not just unlucky developers but also a huge part of the economy. We know that factory utilization is down to 70%, a pretty bad number.
Debt-financed investments
Given all of the above, we can conclude that most of China’s recent growth is based on debt-financed excessive investments in unneeded capacity. The stimulus policy aimed at countering the ill effects of the 2008 international financial crisis led to a colossal level of malinvestment.
Still plenty of cash
The Chinese Government does not have to pull the plug, right now. It still has plenty of cash reserves (trillions of dollars) to fuel this madness a little longer. But how much longer? How much more good money can they throw at zombie companies, in order to prolong the illusion that they are viable? How much more cash will they use to support shares that investors would love to unload?
It is a political issue
In the end, this is not an economic policy issue. This is a political issue. In a true free market, the state would not massively intervene in the economy. It would allow private companies to compete, while allowing foreign investors to participate on an equal base. This way, without state interference, markets would eventually re-balance demand and supply.
But it is hard to see how China can get from here to there. Hard to believe that the national leadership will liberalize the economy right now, when things are slowing down. There are just too many risks.
Without the recent massive interventions, the Shanghai Stock Market might have collapsed, this way ruining tens of millions of small investors. Likewise, forcing zombie firms to shut down may be good for the future health of the Chinese economy; but it would cause short term misery for millions of workers, suddenly without a job.
The instinct is to control
I just cannot believe that a political leadership that can claim legitimacy mostly on the basis of a long (past) record of impressive growth would accept a most serious retrenchment of the Chinese economy. Their instinct is to intervene, extend credit, mask problems, and prop up failing companies.
Of course, this means burning cash for no good economic purpose. But this is the only way to survive politically, at least for a while.