China's stock market crash: A red flag

http://www.economist.com/blogs/freeexchange/2015/07/chinas-stockmarket-crash

by anigbrowl • 11 years ago

90 82 11 years ago

x5n15• 11 years ago

yes just like 'murica's debt. command economies don't play by any given set of rules. they make their own rules. as long as there is demand in the world for chinese goods, the chinese economy will continue to function.

fennecfoxen2• 11 years ago

I don't know how much that's true.

China's current economy is built on the impact of its 1-child policy on its historical culture of children taking care of elderly parents: that's really really hard to do now, so everyone saves like crazy, and the government uses those savings (in state-run banks) to finance state-run industries with below-zero real interest rates, which are of course wildly profitable, and the plutocratic elite splurges on its take of the surplus.

But they really need to watch out for a number of shocks, of the whole scheme could fall apart badly and spark social unrest. In particular, inflation (eating away at those savings) sometimes leads to riots, and their monetary policy has been very extreme for many many years. (In different ways than US policies, but still, makes "Helicopter" Ben Bernanke's interventions look like the amateur leagues.)

Economists continue to worry and it's not 100% clear that China will continue to function after a real economic crisis. They might, but it's really hard to tell (they're so opaque it makes detailed analysis impossible).

x5n15• 11 years ago

What if I was to tell you that all the money that you deposit in the banks is not used for anything. The banks borrow money using a credit lending window from the central banks. They can get as much money as they want. Money doesn't actually exist. It's a virtual method of coercion to get people to do things. As long as there are things for Chinese people to do, the Chinese economy will keep running. As long as China can source raw materials and sell them for a markup to someone else, the Chinese economy will keep running. At the end of the day even if robotics threatens the Chinese economy, the government can step in and stop robotics from destroying jobs. That's the level of control they have. Any problems that they will have economically, everyone else will have first.

Most of these pundits that run Western economies follow rules that they themselves make up, and then use those rules to control other people. But China don't play these games homie, China knows the game homie. China make its own rules.

mahranch• 11 years ago

They might, but it's really hard to tell (they're so opaque it makes detailed analysis impossible).

This is actually one of the reasons why I think China is going to be worse off. More uncertainty means less foreign money coming in which is a bit of a viscous circle. Economies can't grow at a specific rate forever. There will be ups and downs, sharp rises and bubbles. As much as China tries to mitigate them, the can't fight it forever.

Also, the government has total control of their monetary system. While helpful in times of economic uncertainty (they can keep propping it up, even beyond what the U.S can/will do), it shows that China's Yuan isn't ready to replace the dollar. No country is going to want to go all in on a currency where the nation could pull the rug out from under you at any time. They would be beholden to China, and give up more 'power' than they do with their competitor, the U.S. China also ranks 100th on the global corruption index (http://www.transparency.org/cpi2014/results). There are 99 countries less corrupt than China.

It truly and really is like the U.S is a legitimate bank with rules and regulations while China is more like the Mafia's version of bank, where they make their own rules and have no regulations or checks & balances on themselves.

curiousjorge6• 11 years ago

What's ironic about the Chinese stock market is that it's incompatible with Beijing's controlled economy. Knowing this, we can see just how desperate the central leadership is getting with appearing to have control.

The stock crash is particularly dangerous for Chinese leadership at a time when people are becoming fed up with the wealth gap. Wiping out the wealth of its citizens will have catastrophic results for the communist party. Attempts to distract the public with territorial disputes will continue and eventually lead to military conflict should the leadership feel threatened by social unrest.

The mounting debt in China, corruption, social issues, stock crash is a perfect brewing for a pivotal change. Historically, such conditions have led to a military conflict, or invented threat to drum up nationalism. But none of this works if the people feel like they got robbed, which in this case, Chinese government has actively encouraged people to put their life savings into stock market and at high leverages where an enormous chunk of the population will become homeless overnight should the market crash.

Pyxl1012• 11 years ago

Limitations on short selling always concern and perplex me. Why is that a good idea? Isn't that preventing the market from properly adjusting to whatever circumstances have occurred, or new information that has arrived? Limitations like this feel like "Let's all pretend that the truth isn't true".

It astonishes me that in this day and age there are still so many arbitrary controls on marketplaces, such as the Greek stock markets shutting down due to their financial crisis. Isn't it important for the market to adjust and properly accommodate those events? (If the market simply cannot function due to the crisis itself, then that makes sense. I assumed it was shut down because people are afraid of how prices will change as a result.) Sure, some people might panic in an unreasonable way, and if they do, they will get taken to town by other people who go long during the same time period. Just like people who are overly confident will be taken to town by short sellers if there's a bubble and it bursts.

I understand why there are controls on the marketplace like around prohibiting naked short selling, or reversing transactions that were obviously erroneous, but controls like preventing short selling seem absurd. If someone wants to bet that prices will decrease, let them! That's an important signal and an important correction to the market. Perhaps we would have fewer market bubbles if there was more continuous correction.

Is anyone working on a bitcoin-based stock market with no limitations on trading? Could such a thing be legal? Perhaps actual shares of stock are not being traded, but rather some other kind of financial instrument that represents the right to the upside or downside of some shares without having to own them, but you own the upside or downside. Then the idea would be that anyone can buy these instruments using currency or bitcoin on a market that operates differently than today's conservative markets.

I imagine this is probably illegal for a variety of reasons, such as "know your customer", but it's interesting to think about. How would the stock market be different if trades were unregulated, in the sense that there are no limitations on buying and selling shares. It operates 24/7 and never shuts down no matter what happens, and never imposes constraints on selling or short selling. I imagine this market would need to operate as a central authority or federation of trusted brokers (someone needs to verify that the seller actually owns the shares they've promised to deliver), but the authority or brokers would be willing to transact in both regular currency and bitcoin. Would this be a more effective market, or a dysfunctional one, and why?

dflock• 11 years ago

This would be true if people always behaved like Econs, not Humans. In normal times, the mass market averages out irrational behaviour (and there's less of it when things are calm) - but, occasionally the herd stampedes. Perhaps it's better in these cases to slow the panic until things calm down and people start behaving more rationally again.

There are also cases where people individually rationally maximizing their individual financial interests is, collectively, devastating for society as a whole.

Continuous adjustment sounds great, but sometimes we get crashes, which aren't.

Pyxl1012• 11 years ago

Fair point. However, how do we know if that's better or not? Perhaps it's better for those who remain rational during a crisis to accumulate more wealth by enabling them to place bets opposite the stampede. When the next crisis happens, they'll own a greater percentage of the market, and will act to correct irrational behavior. By placing limitations on short selling, we are helping the irrational people at the expense of rational insightful people.

I dislike the idea of these market closures or limitations on short selling because it essentially implies that people can't be responsible for themselves and their own decisions. People have agency and can decide what's best for them. If that's following a herd or opposing the herd, so be it. Perhaps the world would be better off if our systems were designed to more fully embrace meritocracy, moral hazard, and responsibility for one's self.

My experience tells me that giving people more responsibility tends to help them grow: they make their own decisions and learn from them. Taking away that responsibility minimizes risk in the short term, but also minimizes growth and upside in the long term. Maybe this is true at a larger scale in our markets as well. Obviously it's hard to know for sure one way or another.

georgebarnett• 11 years ago

It's curious that there's only intervention in the markets when they're tanking. If the underlying reason for the intervention is to prevent irrational behaviour then where was the regulator when the price was going up like wildfire? Surely it should work both ways?

baddox• 11 years ago

This would be true if people always behaved like Econs, not Humans

And your solution is having an elite class of Humans (again, not Econs) solve this problem by deciding what other Humans can and cannot do?

omarforgotpwd• 11 years ago

sounds like someone read Misbehaving by Richard Thaler, which I'm about halfway through right now.

Great book on behavioral economics, and Thaler's academic career, for anyone who hasn't read it.

davnicwil2• 11 years ago

When you say bitcoin-based, are you implying a pseudo-anonymous, black market? To avoid all existing laws and regulations it'd have to be, right?

One problem that immediately comes to mind with such a market is insider trading - how do you prevent that?

bsder2• 11 years ago

One problem that immediately comes to mind with such a market is insider trading - how do you prevent that?

Why bother? The presence of HFT shows that insider trading doesn't seem to have as much of a detrimental effect as people claim.

Now you may need a couple of laws about primary insiders (corporate officers), but otherwise, let it go.

The insider trading laws only punish the little people, the big fish are all doing insider trading anyway (see US Congressional returns on their stock market investments).

ISL• 11 years ago

Short sellers historically get a bad rap. If the price of something is crashing, anyone reaping profits from the calamity will make a good scapegoat. It's simple to argue that short selling might amplify market fluctuation.

It takes time and financial sophistication to understand that short-selling can be a healthy thing.

skylan_q• 11 years ago

Short positions themselves provide a signal as to whether market participants believe the price to be too high. Giving the opportunity to short thus keeps downward pressure on prices.

Although I'm not entirely sure why there was a sudden run-up and a sudden crash in the stock market in the story...

joshu• 11 years ago

some other kind of financial instrument that represents the right to the upside or downside

congrats. you have a few years of reading to do about how the world works before suggesting alternatives.

icebraining• 11 years ago

Your point is valid, your condescension on the other hand is lamentable.

bobcostas552• 11 years ago

There is complete consensus among economists that short selling constraints are a bad idea. The effect is simply to artificially inflate prices. Typically they're used as a political tool in situations where inflating prices is the whole point.

The Greek stock exchange is a different deal. The banks are closed, without a payments system I don't see how a stock market could operate.

As for the contracts you describe, they already exist in various forms (though not denominated in bitcoin): there are single-stock futures and CFDs, but the former are completely illiquid and the latter aren't a market of their own but usually a pass-through mechanism for regulatory arbitrage.

gutnor• 11 years ago

the latter aren't a market of their own but usually a pass-through mechanism for regulatory arbitrage.

Out of curiosity, what do you mean by that ?

So I get that CFD are not traded on a central exchange, and are custom investment product provided by some financial institution. So indeed not really a market.

However, besides that they seems to be used by regular investor for, well, regular speculation.

marme• 11 years ago

this makes sense in a fair market where trading is fair but in china the market is far from fair and the government hates to admit that but insider trading is rampant. Many of the short sellers are the majority stockholders in the companies they are shorting. These are people who have greater than 50% ownership in some of these companies and they are shorting their stock to make quick money off people with little risk.

tomp2• 11 years ago

One of the restrictions on short-selling is the "uptick rule" - you can only sell a stock short if the last tick (transaction) was higher than the one before - i.e. if the stock was going up (at least momentarily). It's used in Western markets as well, AFAIK. Personally, I think it makes a lot of sense, because it prevents you from short-selling during a crash, exacerbating the panic. The reality is, markets rarely panic upwards, but quite often panic downwards.

jamespitts3• 11 years ago

How to get a read on mainland stock prices:

Over the years I have used FXI to watch general stock prices in China. But FXI only indexes the large cap stocks listed on the Hong Kong Stock Exchange.

Since the mainland stocks began reversing after the extreme price rise, I found the Shanghai stock exchange composite to be far more useful than FXI. To get the current price, use "Deutsche X-Trackers Harvest CSI 300 China A-Shares ETF":

https://www.google.com/finance?q=NYSEARCA%3AASHR&ei=Uj6cVcG4...

Any ideas about how to easily get the price on an index covering the Shenzen stock exchange?

jdhawk• 11 years ago

SICOM:IND and SZCOMP:IND?

http://www.bloomberg.com/quote/SICOM:IND

http://www.bloomberg.com/quote/SZCOMP:IND

jamespitts3• 11 years ago

Excellent -- thanks!

curiousjorge6• 11 years ago

How can we, as North Americans, profit from China's demise? Is there a Chinese index that I can short? Because it sure as shit not going to go back up, not after the recent announcement of buying up bad chinese stocks.

etrain• 11 years ago

There are a handful of Chinese index ETFs out there - FXI is the biggest one - but there are others you can probably short like the MCHI or the GXC.

If you really like to gamble you can buy puts on some of the bigger ones.

curiousjorge6• 11 years ago

Long puts on FXI, but I bet the premium is really high now because of the expectation China is going to tank in a very short period of time (-20% of their annual GDP in 3 weeks). The unexpected event would be a major rally.

vegabook6• 11 years ago

Just sell some aussie dollar or for the brave, buy USDZAR. Much more liquid than the stocks, and exposed to all the second order factors which are already priced into stocks but not yet into the the implications for currencies: lower commoditiy prices, structurally lower demand for Australia's output, less Asian capital investing in the country.

The ZAR angle gives you exposure to a possible slowdown in the huge Chinese investment in Africa, plus the dire politics in SA. The downside is people are already short the unit.

curiousjorge6• 11 years ago

I also thought about shorting Canadian banks, especially Vancouver, the joke is that there's not many corporations traded on stock exchange, but I feel like the Chinese economy crashing would send ripples here where Chinese money is keeping BC afloat, especially when the real estate bubble here pops, we will see vast majority of homeowners using debt to make payments default.

drcode• 11 years ago

The flip side of this is whether "rich people" outside of China already currently have vehicles available to get exposure to Chinese stocks. I hope the answer is "No" so that we don't all of a sudden hear that Morgan Stanley et al had exposure to the Chinese market using some exotic investment vehicle and we suddenly find out there is financial contagion outside of Chinese borders.

Mikeb853• 11 years ago

Of course they did. I trade in China myself, and I'm a 'retail' investor (thankfully I got my money out awhile back, the valuations got silly so I just took profits). Every major bank from every country has a trading presence in Hong Kong at the very least, and many trade in Shanghai too.

If it makes you feel better, the smart money is already out, that's what triggered the crash in the first place. Now everyone who took out margin is trying to get out, and eventually the market will level out. Probably much sooner than people expect.

jrehor• 11 years ago

Futures on FTSE China A50 index trade on Singapore Excbange and are available to US investors via Interactive Brokers (ticker XINA50). They are quite liquid. Have fun!

jonnycat• 11 years ago

If you had the stomach for such a thing, you might want to look at YANG, a 3x leveraged bearish China ETF, which is up about 30% over the past 3-4 days. Careful though - it will move just as quickly back down if the Chinese market recovers at all. I think the quote "markets can remain irrational longer than you can remain solvent" may apply here...

curiousjorge6• 11 years ago

what the...why is it up? this ETF is bonkers, it's actually been trending downwards for the past 3 years.

amen to that quote...this one is a little too hot for me, might stick to the other ETFs mentioned below.

Mikeb853• 11 years ago

Because it sure as shit not going to go back up

Of course it will. It's not even down on the year.

It's profit taking which triggered a whole bunch of stop-losses, margin calls and panic selling. Wait for the volatility to die down, and buy H-shares (or A-shares if you have the stomach).

To understand why it's going down so fast, you need to understand how fast it went up. As it stands today, the SSE is still up almost 100% in the last 12 months...

jamespitts3• 11 years ago

The shadow banking sector in the mainland worries me more than anything else in this emerging situ. It is an information problem, but magnified by the potential for political distortion or simple opacity. In freer societies, the issue is merely a gap between expectations and emerging reality, and we know how extreme even that can get.

A lot of firms may be severely impacted by this share price collapse, both financial and non. More alarmingly, "shadow" bank failures may occur unseen, or structural problems that would normally be covered or speculated about by the media suddenly rear their head. We may only find that large sources of financing vanish long after the fact.

Many expect the CCP to swoop in and save the day, but perhaps it chooses to not do so, or do something more extreme than changing some rules or commanding the buying of shares in the big indexes.

fokinsean• 11 years ago

First Greece, then China, coming up soon is Puerto Rico, is the US next?

vegabook6• 11 years ago

Inevitably, whenever The Economist (or the press in general) latches onto a markets story, it's because everything is already in the price. Shorts should be taking profit here, because the journos are usually the last to know. Recall, this is the paper which wanted to sell gold at 300, and wanted to sell oil at 11.

leoc3• 11 years ago

Bet you $5.

vegabook6• 11 years ago

Bet me what? That SHANCOMP will go lower from here? And I assume you already know that your payout will be skewed: options price in a higher chance of downside than upside already so you should probably pay me $7 if it rallies against my $5 liability if it falls. Point is: this "China is tanking" idea is on everybody's lips and the surprise risk is now a rally.

RachelF• 11 years ago

Indeed - The Economist is a great contrarian signal. A month ago they ran a story about how well the Chinese market was doing.

In my experience, they either latch on too late, or way too early.

smaili• 11 years ago

Note: I'm not an economics expert by any means, so go easy on me :)

I'd just like to ask why in situations like this, governments tend to intervene? In the long term, wouldn't it actually be better to let the market just naturally figure itself out? That way the end prices reflect the real value.

aluhut• 11 years ago

I think to much on the market has no real value.

chimeracoder• 11 years ago

Note: I'm not an economics expert by any means, so go easy on me :)

That's fine - I have a degree in economics, so let me take a stab at explaining this!

why in situations like this, governments tend to intervene? In the long term, wouldn't it actually be better to let the market just naturally figure itself out?

As Keynes said, "In the long run, we're all dead".

The problem is that the "long run" doesn't actually correspond to any specific duration of time or point in the future; it describes the aggregate, idealized behavior over time. There may actually never be any point at which the trading price of $XYZ[0] actually matches the underlying value, as long as the price over time tends to track the fundamental value[1].

On the other hand, an overfocus on optimizing for the short term causes stunted economies that never reach their full potential (in the best case) and a downward spiral with a negative feedback loop (in the worst case).

That way the end prices reflect the real value.

By the way, there's actually no such thing as the "end price", because nothing happens in a vacuum. Let's say Google launches a new product today. It may take two years to figure out whether or not that product is going to be a success[2]. If they did nothing else in that time, then yes, there would be an "end price" after this event, but the real world is a series of overlapping events that are all playing out simultaneously[3]. So the market never has the chance to converge towards the "end" value after event A, because by that time, events B, C, and D are all having an effect on the system as well. That doesn't mean that A's effect is negligible; it just means that it's never observed directly.

[0] By the fundamental theorem of calculus we would be guaranteed this at one moment, but prices aren't actually continuous so this doesn't apply

[1] The fundamental value, of course, can never be directly observed, as is often the case in statistics.

[2] Or even ten years, if we're talking about self-driving cars.

[3] The word "event" here is a technical one, not a colloquial one: https://en.wikipedia.org/wiki/Event_study

frozenport• 11 years ago

>That way the end prices reflect the real value.

Is hype the `real value`?

discardorama• 11 years ago

I'd just like to ask why in situations like this, governments tend to intervene?

I'm not an economist either, so consider this a case of blind leading the blind.

My interpretation is that market crashes lead to public turmoil; and given China's history of revolutions, the government isn't too keen on a large, unhappy public. I've read that a lot of people entered into the market late, and often borrowed funds to do so (I have no citation, unfortunately). I bet those people would be pissed if they lost all their money and then some.

Reminds me of the last dot-com crash. As the saying went, when grandmas start jumping into the market chasing hot stocks, it's time to get out. (No offence to any grandmas out there!). I have a feeling the same was happening in China recently.

lmm2• 11 years ago

A free market can't handle limited liability. It's only government intervention that can provide things like orderly bankruptcy proceedings. If the government is obliged to be a lender of last resort then it seems reasonable for it to take less binary steps before that eventuality.

tomp2• 11 years ago

A free market can't handle limited liability. It's only government intervention that can provide things like orderly bankruptcy proceedings.

Obviously. And it's the government that actually establishes the free market, regulates it, and provides all the surrounding infrastructure (roads, police, courts, ...).

A "free market" doesn't mean that you can do whatever you want - the name for that is "anarchy". Free market only means that everybody is free to compete under equal terms. Additionally, governments would step in if a single player got too powerful and would exert its power in ways that would undermine competition.

Mikeb853• 11 years ago

I'd just like to ask why in situations like this, governments tend to intervene?

Because ordinary people likely gambled with their savings, and since they're not as savvy as the hedge-funds and professionals, they stand to lose quite a bit.

But yes, it would be better to let the market figure itself out. Valuations did get a little out of control, hence the large crash.

tokenadult• 11 years ago

The Los Angeles Times reporting about the first two days of trading this week in China[1] is also interesting for perspective on how the stock market in China influences the broader economy of China. The key idea is that the current situation, even WITH government intervention, is very likely to severely hurt the personal savings of a lot of households in a country with a strong tradition of personal savings. That could turn many well educated, high-earning people who were previous supporters of the Communist Party of China leadership of China into doubters about their government or even regime opponents.

The CNN report based on official media reports from China strongly suggests many economic upheaval from the current intervention in the stock market in China.[2] The most dynamic and innovative companies in China are those most likely to be unable to raise further investment funds.

[1] "It's a bumpy ride for China's stock market investors"

http://www.latimes.com/world/asia/la-fg-china-stock-market-2...

[2] "Nearly 25% of Chinese stocks have stopped trading"

http://money.cnn.com/2015/07/07/investing/china-stock-market...

China's stock market crash: A red flag

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