The harrowing saga of Greece’s future in Europe had one positive: it distracted the world’s attention from the colossal meltdown of Chinese stock markets and the government's clumsy attempts to arrest the decline.
Friday marked the second consecutive day of strong gains on China's main equity markets, suggesting the weeks-long plunge in share prices may have found a bottom. That will depend on the retail investors’ confidence in Beijing, as the reversal was engineered by an array of measures that show China is a long way from embracing free-market economics.
The decision of the People’s Bank of China to inject more than $5 billion (US) into the financial system, cut interest rates, and loosen margin requirements was standard enough, drawing comparisons to the "Greenspan put." The measures that followed would have shocked the libertarian values of the fathers of free-market economics. Trading in more than 1,400 stocks was banned and shareholders with large stakes in companies were told they could not sell for six months. Some companies were ordered to start buying shares.
However objectionable some of these policies are on philosophical grounds, the rest of the world can be thankful that Beijing acted aggressively to forestall a calamity that would have had global repercussions. The Bank of Canada said in its June Financial System Review that "financial disruption" in China would have a "moderately severe" impact on Canada's economy. The same could be said of other major economies, which have become increasingly geared to the ebbs and flows of Chinese demand. International trade and commodity prices have suffered as growth in China’s economy has slowed to a pace of about 7 per cent from about 10 per cent in 2010 and about 9 per cent in 2011. Global banks also have become increasingly exposed as Beijing has steadily — if slowly — opened its financial system to international institutions.
The questions going forward are many. The immediate concern is whether Beijing has contained the panic. That will reveal itself in the days ahead. But even if it hasn’t, there is reason to think it can.
A strand of the story of China’s rise is the ability of its policy makers to defy predictions that a booming economy is more than any collection of humans can manage. They also have plenty of money at their disposal. Despite its concern about China, the Bank of Canada in its financial stability report conceded that Beijing had sufficient resources to protect the financial system from widespread defaults in the shadow banking industry, were they to occur.
To be sure, Canada’s central bank said that any rescue likely would be expensive and painful — “there would be significant challenges to preventing a hard landing in the economy,” the Bank of Canada said. The events of the past few weeks underline that concern. Bloomberg estimates that almost $4 trillion (US) in paper wealth was lost in the collapse. That’s the toll from a collapse that appears to have been contained. The mind boggles at what could happen if Chinese authorities actually lose control.
Of course, as yet unseen damage may have been done.
The Chinese Dream of Western exporters is the emergence of a massive middle class with cash-positive deposit and brokerage accounts that its members regularly leverage to buy stuff. This dream could be at hand, as more and more Chinese seek to earn a little extra from their savings, which equal about 50 per cent of GDP. The first evidence of change in financial habits was China’s housing boom. When authorities moved to deflate the real-estate bubble, savers started shifting their excess cash to stocks.
This is what Beijing wanted. Authorities loosened restrictions on equity investing as it tightened those on housing. But the government, too, may have been captured by the exuberance. Among its encouragements was a decision to allow investors to open as many 20 trading accounts from one previously, a policy that was dangerously pro-cyclical.
DBRS, the bond-rating agency, said in a July 9 commentary that the Communist party may become slow in its liberalization drive. That would be a natural response to what has just happened. However, a backtracking seems unlikely. China has come too far.
The bigger worry is the psychological effect the episode will have on retail investors. The best-case scenario is that they see the 30-percent decline in June and July as a correction that momentarily got out of hand. Between November 2014 and June 12, 2015, the Shanghai-Shenzhen 300 Index surged 108 per cent. Even after the selloff, many investors will be ahead. If Beijing inspires confidence, then the rally could resume. The wealth effect should trickle down to spending and help global economic growth.
But what is unclear is how many individuals suffered during the collapse. The surge was driven by margin lending. Any investors who borrowed to buy at the peak could be in trouble, even if the worst is over. And the dream of the Chinese middle class driving global economic growth would be further delayed.