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China Destroyed Its Stock Market In Order To Save It
Submitted by Patrick Chovanec via ForeignPolicy.com,
During the Vietnam War, surveying the shelled wreckage of Ben Tre, an American officer famously remarked, “It became necessary to destroy the town to save it.” His comment came to epitomize the sort of self-defeating “victory” that undoes what it aims to achieve.
Last week, China destroyed its stock market in order to save it. Faced with a crash in share prices from a bubble of its own making, the Chinese government intervened ruthlessly, and recklessly, to turn those prices around. Its heavy-handed approach seemed to work, for the moment, but only by severely damaging far more important goals and ambitions.
Prior to the crash, China’s stock market had enjoyed a blissful disconnect from reality. As China’s economy slowed and corporate profits declined, share prices soared, nearly tripling in just 12 months. By the peak, half the companies listed on the Shanghai and Shenzhen exchanges were priced above a preposterous 85-times earnings. It was a clear warning flag — one that Chinese regulators encouraged people to ignore. Then reality caught up.
At first, when prices began to fall, the central bank responded by cutting interest rates and bank reserve requirements — measures to inject more money that had never failed to juice the market. But prices continued to fall. Then the government rallied the major brokerages to form a $19 billion fund to buy shares and waded directly into the market to buy stocks too. A few stocks rose, but most fell even further.
The relentless crash was intensified by a new factor in Chinese markets: margin lending. Chinese punters were borrowing in large sums, from both brokerages and more shadowy sources — like “umbrella trusts” and peer-to-peer lending websites — to buy shares, with the shares themselves as collateral. At the peak, according to Goldman Sachs, formal margin lending alone accounted for 12 percent of the market float and 3.5 percent of China’s GDP, “easily the highest in the history of global equity markets.” Margin loans served as rocket fuel for the market on its way up, but prices began to fall and borrowers received “margin calls” that forced them to liquidate their positions, pushing prices down further in a kind of death spiral.
Chinese regulators, who had been trying (ineffectually) to rein in risky margin lending, now suddenly reversed course. They waved rules requiring brokerages to ask for more collateral when stock prices fall and allowed them to accept any kind of asset — including people’s homes — as collateral for stock-buying loans. They also encouraged brokerages to securitize and sell their margin-lending portfolios to the public so that they could go out and make even more loans. All these steps knowingly exposed major financial institutions, and their customers, to much greater risk. Yet no one will borrow if no one is confident enough to buy, and the market continued to fall, wiping out nearly all its gains since the start of the year.
By this point last week, China’s state media was talking openly of a “war on stocks.” And in that war, China’s leaders chose to employ the nuclear option: In effect, they closed down the market and outlawed selling. As of the morning of July 10, about half of China’s 2,800 listed companies filed to suspend trading. Many of their owners had pledged shares as collateral for corporate and personal loans and were facing margin calls that would cause them to lose control of their companies. Chinese regulators also banned major shareholders from selling any shares for the next six months. Additionally, they directed companies to start buying back their own shares and instructed state-run banks to provide whatever financing was needed.
But the real turn in the market came when China’s Ministry of Public Security — the no-nonsense tough guys normally tasked with cracking down on political dissent — announced that it would arrest what it called “malicious” short-sellers. It was clear, however, that this meant anyone whose selling (not just “short” selling) interfered with the government’s efforts to boost prices. The announcement cast a chill over the market. I have heard multiple reports of Chinese brokers refusing to accept sell orders for fear of angering the authorities. So when we say China’s stock market stabilized, we need to put quotation marks around the word “market.”
China’s temporary success at manipulating a share-price rebound has come at a terrible longer-term cost.
Two years ago, China’s leaders adopted “market forces will be decisive” as the guiding principle behind a much-lauded push for reforms needed to reinvigorate China’s slowing economy. That principle now lies in ashes.
For years, China has dreamed of Shanghai’s becoming a global financial center. Now, one analyst at the global investment firm Julius Baer told the Financial Times, “confidence in the local Chinese equity market has been shattered and is unlikely to come back anytime soon.” Just a few weeks ago, observers confidently predicted it was “inevitable” that domestic Chinese stocks would soon be added to the major global indices that serve as benchmarks for professional investors. Today, with a mere rump of China’s stock market trading at all, and with investors afraid they will be thrown in prison for selling at the wrong time for the “wrong” price, it’s inconceivable.
It didn’t have to be this way. Some compare China’s intervention to the U.S. Troubled Asset Relief Program (TARP), but the difference is striking. TARP didn’t try to stop market prices from falling; it focused on containing the damage. If Chinese authorities identified a large securities firm that was at risk of failing from bad margin loans and stepped in to prevent a chain reaction, that would make more sense — and do a lot less damage — than trying to prop up the entire stock market by fair means and foul. Memories are short, but in 2007, China allowed an equally large stock bubble to collapse without its economy suffering irreparable harm. Caixin, one of China’s most prominent financial magazines, argued recently that this time around, the government “had no reason to intervene” to prevent a much-needed market correction and had grossly overreacted.
China needs a functioning stock market that allocates investors’ capital to the most promising enterprises. This means prices that aren’t obedient to the whims of the state, or the party. China may have arrested the stock market’s fall by threatening to arrest sellers. But when it did that, it destroyed the town it was trying to save.
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"I had to abandon free market principles in order to save the free market"
G.W. Bush
http://youtu.be/Tmi8cJG0BJo
The Chinese have learned much from our communist.
this was the staple gun to the head of america
jb
The Chinese showed their hand, they are in no place to facilitate the only thing that could see them to the undisputed head of the world economic table, a free market. The Chinese cannot allow a free market let alone what many think, a gold standard. The powers that be in China will not give up control to a true gold standard which would only put the power into the hands of the people, the same people that they fear above all else.
90% of what the PBOC did... and 99% of what they did up until about 3 weeks ago was perfect
but what in the fuck were they thinking to freeze so many stocks, ban ALL short sales (banning pension fund short sales, sure... western mutual funds can't short sell, etc... but ALL FUCKING SHORT SALES?), and to blame the almight less than 1% foreign investors? stupid stupid stupid
way to waste 2-3 years of hard-earn foreign good will toward the SSE and Renminbi
It was financial sabotage by Western Banks. October and the USD's last dance is right around the corner followed by renimibi revualuation. I will not be surprised if China's gold holdings are reported bi-monthly from now until October, ultimately showing a 300 to 400% increase from last weeks number.
I was thinking the same exact thing.
In fact I think I could replace all instances of the word "China" in this article with "USA" and it would still be correct.
Anybody who tries to defend TARP with a straight face deserves to be ignored.
Those who thought that USA destroyed the stawk market in order to save it back in March 2008 and pulled out of stawks for fear missed one of the biggest Bubble Creations in history. [Note: I don't call it a "Bull Market" b/c that implies the rise in stawks was due to fundamentals which it obviously was not.]
That's why the several Chinese at work told me their relatives were doubling down on their holdings over there since they know the Gubmint will copy the USA model.
It's a very distrubing time to be alive and try to protect your hard earned money from being defrauded away, debased, or Looted in some other fashion.
this hard earned money is labor/time, something that can't be gotten back, tic tock mutha fuckers...
So did the United States, but it will not be saved.
And now they will make up for all that by pumping it to alltime new highs and everyone will forget about this "bump in the road" and wish they would have bought stawks in chinkville.
Fuck it - I don't care anymore.
You do. We all do. But it doesn't make any difference.
i second the fuckit attitude, and up the ante to: they can all go fuck themselves...
"At the peak, according to Goldman Sachs, formal margin lending alone accounted for 12 percent of the market float and 3.5 percent of China’s GDP, “easily the highest in the history of global equity markets.”
lol...bye bye bye!
Oh, I thought you were talking about how they allowed all the stuff like short selling and whatnot right before the crashing too.
A Pyrrhic victory is a victory that inflicts such a devastating toll on the victor that it is tantamount to defeat. Someone who wins a Pyrrhic victory has been victorious in some way; however, the heavy toll negates any sense of achievement or profit (another term for this would be "hollow victory").
I think I caught me some of that in Bangkok in '71.
Didn't feel like no victory to me.
If bankers cause us to lose 100% of our money, but they only lose 99% of theirs, they'll call that a total victory because they'd still be far richer than everyone else.
No reserve currency for you, you communist, market manipulating, central planners. Better declare more Gold. That last number was a joke but at least it was bigger than last time.
If China has destroyed their market. Then the every day for 7 year control freaks at the Fed have incinerated theirs.
Or maybe China destroyed its stock market, so the US cannot destroy it at a time of their choice?
So you use money you don't have and pledge collateral you don't own to buy stocks so you can get rich off the profits made using said money and collateral that isn't yours when you sell the stocks.
My god, it's so simple. Why haven't people been doing this all along. Everyone on earth will be rich.
Put me down for one million shares of every company on Earth. I'll be good for it when every share doubles in a month. Then I'll use the profits as collateral for a loan to buy two million shares of each. Rinse, repeat, TRILLIONAIRE!!! Without ever actually having dollar one in the bank.
AWESOME!!!
Interesting that at the same time the Chinese markets were crashing there were all sorts of IT system outages in the US including the NYSE.
http://www.eutimes.net/2015/07/china-warns-russia-that-state-of-war-now-...
love the greater fool saying, ha
check in the mirror just to be certain, ha again
The Chinese Communist Party has a massive collection of plates spinning atop spindles—massive, peak debt, mountains of privileged non-performing loans being subsidized by savers,predatory trade policies with America enabled by corrupt politicians, massive malinvestments in capital destroying white elephant projects, etc.—which to point out the obvious is dynamically unstable. The CCP cannot allow any of these plates to spin down, fall to the ground and shatter, as might happen in even a corrupted, crony capitalistic market, because of extensive and well-justified fears of revolution. Not mere domestic unrest, but outright revolution.
One big question is how much debt has China now incurred in what are going to be obviously non-performing loans? Why non-performing? Well, at an average P/E of 85—85 year payback period—they're obviously non-performing. The consequences from 'saving' the stock market's spinning plates are all of the other plates—housing and real estate market, economic transition to consumer economy, etc.—slowing and wobbling.
The most important and most memorable result is the crystal clear conclusion that China is in every way shape and form governed by the rule of man, that the ends always justify the means. There is no rule of law in China. The CCP will always violate the rule of law to obtain their desired ends. Anyone who thinks otherwise deserves to lose everything they have and ever will have.