Leaked Note By Chinese Think Tank Warns Of Potential "Financial Panic"

It's not just Trump who is concerned about the level of the S&P as a result of escalating trade war with China: it appears that China is growing worried as well, and for good reason - as we noted earlier, the Shanghai Composite already tumbled to a bear market from its highs 6 months ago, a drop which comes at a very precarious time for China whose economy is slowing amid an aggressive deleveraging campaign, corporate defaults are rising, and the all important credit impulse is waning.

Confirming as much, this morning Bloomberg reported of a leaked report from a Chinese government-backed think tank which warned of a potential “financial panic” in the world’s second-largest economy, "a sign that some members of the nation’s policy elite are growing concerned as market turbulence and trade tensions increase."

According to a study by the National Institution for Finance & Development that was seen by Bloomberg News, bond defaults, liquidity shortages and the recent plunge in financial markets pose particular dangers at a time of rising U.S. interest rates and a trade spat with Washington. The think tank also warned that leveraged purchases of shares - i.e. stocks bought with margin loans - have reached levels last seen in 2015, when a market crash erased $5 trillion of value.

"We think China is currently very likely to see a financial panic,” NIFD said in the study, which appeared briefly on the Internet on Monday, before being removed. “Preventing its occurrence and spread should be the top priority for our financial and macroeconomic regulators over the next few years.”

As Bloomberg adds, te study provides "another indicator that China is growing concerned about the knock-on effects of trade tensions with the U.S."

In recent weeks, prominent academics have begun to question if the country’s slowing, trade-dependent economy can withstand a sustained dispute, which has already started to weigh on stock prices and the yuan.

In other words, while Trump may be worried how much of a drop in the market the US can sustain before it impairs midterm election chances, China is just as worried, with the NIFD warning that China had failed to address the issue of leveraged stock purchases, a major contributor to the market collapse three years ago. Such bet reached about 5 trillion yuan ($760 billion), a similar level to 2015, according to the NIFD report.

"We failed to clean up the leveraged funds after the 2015 market rout; they have staged a comeback in a new guise," NIFD said.

As we noted over the weekend, last week UBS said that it sees a growing risk in China's stock pledges; the bank calculated that the market cap of pledged stocks that have fallen below levels triggering liquidation amounts to 440 billion yuan with some 500 billion yuan below warning line, which translates to ~1% and 1.1% of China’s entire market value of $6.8 trillion. A separate analysis by TF Securities, as of Jun 19th, stock prices of 619 companies were close to levels where margin calls will be triggered.

The think tank concluded that China’s State Council should be ready to implement any market support measures in coordination with the central bank and other regulators, key government ministries, and even the police: it was unclear if that implies arresting short sellers as happened shortly after China's bubble popped in 2015.