While the world stands mesmerized by the slow-motion train wreck of Greece, the Chinese stock market is crashing. That is the only word for it — crashing! Since it set a seven-year high on June 12th, it has been losing $145 billion of value everyday. It is now down 32% in less than a month! Take a look at this graph:
You’ll have to look closely, but you can see it has breached the green support line and is still dropping. To a technical analyst, that is a strong indicator of more trouble ahead.
I’m not one to condemn everything that government does, but the Chinese government has been too active in something they don’t understand. First, they liberalized the margin trading rules, which increased the purchasing power of investors. The stock market promptly hyperventilated and soared. Of course, hyperbolic growth usually results in hyperbolic drops. When the drop started, the Chinese government started investing some of its money into the stock market. This showed the government understood that the stock market reflects the supply and demand for stocks. But, it also showed the government doesn’t understand messaging. Their action was meant to say the government will support the market. What it actually said was that even the all-powerful Communist government is powerless against the Capitalistic market, because the stock market continued to fall. Then, the government suspended IPOs, thinking that IPOs drew money away from existing stocks, thus pushing down values. Of course, this didn’t help to arrest the fall either. They also cut trading fees to encourage more investors to buy. Instead, investors benefited from lower trading fees to sell. Then, they told some 1,200 trading firms to stop trading, preventing millions of investors from selling. How can they meet margin calls if they cannot sell? This required those investors to sell stocks they had on other stock markets, creating an unexpected contagion. This is a textbook case of the central government making a bad situation worse! This crash will also increase social unrest in China, something the Communist government is deathly afraid of.
The significance of this is hard to over-estimate. After all, they are the world’s second-largest economy. However, what I really fear is that the combination of the now-manageable Greek tragedy with a crash of the Chinese stock market may overload worldwide investor confidence, making contagion more likely. This Chinese problem is happening at a very delicate time . . .