It had to happen at some point. Just a few weeks ago the Shenzhen and Shanghai Stock Exchanges were collectively worth roughly $10 trillion. Within a single year, the Shanghai Exchange had surged from just over 2000 points, to well over 5000. It was just a matter of time before one of the world’s most expensive bubbles would burst, and it finally has.
While everyone had their eyes on the unfolding crisis in Greece, both of China’s stock markets plummeted 30% of their previous value in June. By all accounts, the bubble was largely fueled by two forces: Average investors taking on debt to invest in stocks, as well as government manipulations.
What’s worse, is how financial institutions in China are reacting to the healthy dose of realism that their stock market so desperately needed.
The country’s top stock brokerages decided to collectively buy almost $20 billion in stocks to help stabilize the market, part of which was supplied by the government. You might recognize this as the award winning strategy that was employed by several top financial firms in the US, just after the market crash of 1929. The Great Depression quickly followed. When a bubble of this magnitude bursts, nothing on Heaven or Earth can stop it. (Take a look at how fast this bubble grew.)
Apparently, the powers that be in China — who are quite adept at monitoring “threats” to the Party line and are quick to remove all traces of “objectionable” material from the internet — completely missed the giant margin bubble that was allowed to inflate outside of brokers’ books. A far more realistic explanation of course is that Beijing was well aware of what was going on but let it continue due to the fact that China’s world-beating equity rally was the only thing distracting the country from flatlining economic growth and a bursting real estate bubble.
As Chinese stocks climbed ever higher earlier this year, some commentators began to ask if a stock market collapse would have implications for the broader Chinese economy. In short, just about the last thing the country needs amid slumping global (not to mention domestic) demand is for a crisis of confidence in local equity markets to spill over into the real economy and derail consumer spending just as Beijing attempts to transition the country away from a smokestack model and towards an economic future characterized by services and consumption.
Generally speaking, the consensus was that any fallout from the bursting of the equity bubble would largely be confined to the financial markets. Now, analysts are very quietly starting to suggest that if the sell-off doesn’t end soon, it could metastasize and spread “far beyond the stock market.”
A possible trigger for a financial crisis in China
If the market continues to fall sharply, stock lending related losses could run into Rmb trillions, of which, banks and brokers may have to bear a meaningful share. These potential losses can be especially dangerous to brokers whose capital base is less than Rmb1tr. Even more important, the opaqueness of China’s financial system and the lack of clear definition of risk responsibility mean that contagion risk is high, similar to the subprime crisis. We had always considered the risk of a financial crisis in China as high. What has happened in the stock market has likely increased the risks considerably and also brought forward the timeline by our assessment – the leverage is much higher now and economic growth rate, potentially lower.
What happens next will be the question. The EU, ECB and IMF will either have to acquiesce or try to push Greece to the brink via closing off the Greek banking system to liquidity which is currently what they continue to try to do.
What we have been saying and predicting for years appears to be coming to a head. We’ve stated that the younger generation will not see any need or incentive to stay with these archaic, bankrupt, tyrannical systems. What does a young, unemployed person in Greece get out of it? The answer was clear in this weekend’s referendum: nothing. So they’d rather take their chances with the unknown than stick with a system that they know offers them no hope.
Most are waking up to the game. Even in the US, 70% of people now believe mainstream media is intentionally biased. In Greece, one of the biggest rallies last week was against the mainstream media! Mainstream media were being shunned on the streets. We’ve seen that before in the US with people attacking CNN reporters and telling them to get out of their communities.
The only way for Greece to truly prosper would be to reduce the size of government by at least 90%, privatize almost everything, do without a monopoly central bank (private clearinghouses are OK provided they are not regulated), reduce individual and corporate taxes to 0% and allow for the market to decide what it wishes to use as a currency. Then sell all government assets including gold, to the private market. With the funds gained from that, pension payments could continue to be made while the entire national pension system is slowly wound down.