China's Stock Market Crash: 11 Things You Need to Know
China's problems go much deeper than just it's stock market. Full story: http://bit.ly/1JPkXqZ
- •China's stock market is crashing, and the Chinese can't seem to stop itOn Monday, China's benchmark Shanghai Composite index fell another 8.5 percent, bringing the market's total losses to almost 40 percent since its June peak. The drop comes after large losses earlier in the summer. What's perhaps more worrying than the actual losses is the Chinese government's inability to stop them.
- •China's stock market boom is built on debtInvesting borrowed money used to be heavily restricted in China, but the authorities have loosened the regulations since 2010. The result has been an explosion of debt-fueled trading. And it's not just margin debt. People have been finding creative ways to evade the regulations the Chinese government left on the books (as detailed in a helpful May report from Credit Suisse). So there's yet more risky debt, and yet more risky trades, than that chart suggests.
- •Most of China's new investors don't even have a high school educationOptimistically speaking, individual borrowers don't create systemic risks. A bunch of farmers going bankrupt doesn't imperil the global financial system. But these borrowers got into the stock market because the Communist Party, in word and deed, was pushing them. Then the market crashed. They will be justified in partially blaming the government for their losses, and the Communist Party has never been particularly good at dealing with widespread anger at the regime.
- •The Chinese government's failure to stop the crash is rattling markets even moreThe fact that all this intervention hasn't been enough has scared markets yet more. "Beijing’s inability to stop the recent decline has rattled investors who have long been used to seeing the government use its power to control markets," reported the Wall Street Journal in July. This most recent sell-off follows months of overwhelming, and seemingly successful, intervention from the Chinese government, and so it's yet more proof that the situation may be spiraling out of their control.
- •China's stock market is big — but it's not that bigYou might think, given that the stock market plays a small role, that the Chinese government wouldn't much worry over the gyrations of the stock market — after all, it's still up from last year. But the stock market's crash comes on the back of broader woes in the Chinese economy. Growth has been slowing for years, and economists broadly agree that the country's export-driven economic model needs a (possibly painful) overhaul.
- •The deeper problem: China's export-based model has stopped workingChina's stunning economic rise has been fueled by low-cost exports. But as its economy has grown, the export model has begun to crack apart. "It has outgrown the export-led growth model that led it to rely on external demand and high internal investment," says Patrick Chovanec, a longtime China watcher who is currently chief strategist at Silvercrest Asset Management. "So now it needs to shift to a model that is more balanced between investment and consumption."
- •China's Communist Party is unusually scared of slow growthChina's official inflation-adjusted growth rate in 2014 was 7.4%, and the economy is growing, according to official (and, some believe, inflated) statistics, at about 7% in 2015. In the Communist Party's view, this is the basic bargain they have made with the citizens of China: The people give them power, and they give the people growth. If they stop giving the people growth, well, the people might stop giving them power — and no one knows what will happen in that scenario.
- •China's leaders have less power to direct the economy than many thinkOne place this plays out is in steel production. China has long produced and exported way too much steel, flooding global markets and keeping China's economy on the export-led model it needs to drop. So, almost every year, China's leadership comes out and announces that it's going to cut steel production. And, every year, steel production does the opposite: It goes up. The leadership can't pull off an economic transition to a consumer economy unless the larger system wants to make it happen.
- •China's government is terrified of economic problems leading to social unrestThe Chinese Communist Party is fears that economic crisis could lead to social unrest, and that social unrest could lead to utter catastrophe. That was a chief lesson it took from the 1989 Tiananmen Square protests, which were spurred in part by economic problems, and which Beijing saw as so dangerous it deployed tanks into the streets. China's leaders are willing to go to extraordinary lengths to prevent that from happening again, which in economic terms means keeping growth up.
- •China's leadership has managed to resolve economic crises in the pastOne reason there is tremendous debate among China watchers over the health of China's economy is that on the one hand, there are indicators that the system is fundamentally unhealthy, but on the other, the leadership has shown time and again that it can resolve the crises these problems create. The current stock market crash is just the latest in a very long series of economic and political crises that have hit the country: the 2011 Wukan village protests, for example, or the 2013 credit crunch.
- •It's dangerous for the world to lose faith in China's governmentBad decisions made by the Communist Party will force the world to reevaluate a critical investment premise: that China's government knows what it's doing. China's stock market isn't that big, and because regulations sharply limit foreign investment, it isn't that integrated into the world economy. So the consequences of a stock market crash aren't that severe. But the consequences of political unrest in China, or a true economic crisis, could be real, not the least for all the Chinese people.