The China syndrome

Michael Raffety

Aug. 24, 2015

The 1979 Michael Douglas movie of the same name about a nuclear plant meltdown featured the fanciful notion that it could melt all the way through the earth to China.

Now we are left to ponder if a Chinese stock market meltdown could go all the way to the United States.

By Aug. 29, 1929, margin selling and stock buying frenzy had reached a level that two-thirds of the face value of stocks was money loaned by brokerages. That amounted to $8.5 billion, which at the time was more than the amount of money in circulation in America.

From January through June 12, 2015, the Shanghai Composite Index shot up 60 percent, a seven-year high. However, in the same period the Hang Seng China Enterprises Index, “which tracks the performance of some of the largest Chinese companies listed in Hong Kong rose 17 percent.

June 12 is the key date. After that the Shanghai Composite plunged 25 percent.

By comparison, the Dow Jones Industrial Average peaked at 381.17 on Sept. 3, 1929, later dropping 11 percent on Oct. 24, followed by 13 percent and 12 percent in that month. The 1929 crash didn’t completely play out until 1932 when the Dow sank to 41.22 – an 89 percent loss from its high. It wasn’t until Nov. 23, 1954, that the Dow Jones Industrial average reached 381 again.

China’s Shanghai index has ballooned as much as 162 percent and shrank as much as 30 percent. Swelling between June 12 and July 5 wiped out $1.25 trillion in market capitalization, a figure that grew to $.3 trillion by July 8.

The Wall Street Journal has thoroughly covered the Chinese stock market insanity. The Journal’s sources are wide and varied, featuring multiple stories in each issue from July 3 through July 14.

Enter the dragon

China’s two stock exchanges had been moribund until the government began encouraging margin buying. But once the individual stock buyers could buy on the margin the Chinese market went bonkers. From 3,324 on Dec. 31, 2014, the Shanghai Composite shot up above 5,000, then started sinking.

The Chinese stock market, though wild, is a rigged system, run by a Communist dictatorship. On June 27 the Peoples Bank of China, a communist version of the Federal Reserve, began injecting funds into the market. Two days later the PBOC cut interest rates. July 3 China’s stock regulator said investors could borrow against their homes to invest in stocks. On July 5 the PBOC announced it would “provide liquidity assistance” to China Securities Finance Corp., which is owned by the stock regulator. The money was loaned to brokerages to make loans to stock market investors.

That’s not all. The government owns the media. On July 6 the People’s Daily newspaper said markets will stabilize and that “rainbows always appear after rains.”

Also over the July 4 weekend the communist government halted all new Initial Public Offerings of stocks.

Meanwhile, state controlled securities firms, mutual funds and China’s sovereign wealth fund all said they would buy stocks. Then July 8 the Chinese Communist government suspended trading in almost half the stocks on major indexes.

The Xinhua News Agency shot lightning bolts at slick American hedge fund investors shorting the Chinese market, saying Chinese police were investigating “malicious short selling.”

Economy decelerating

American investor James Chanos said the Chinese economy “has been on a five-year glide path downward” that will continue. Other investors, including Vanguard, Fidelity and Nuveen are sticking with Chinese stocks.

Consider that new passenger cars in China fell 3.4 percent in June, the worst performance since September 2012. China has geared down its growth prediction from 7.5 to 7 percent but first quarter year-over growth was 4 to 4.6 percent, according to U.S. analysts, and producer prices are declining. Citibank estimates China’s actual annual growth rate is about 5 percent.

America auto sales in 1929 declined and so did steel production and construction. China’s unemployment rate declined to 4.1 percent, but government controlled companies are keeping bloated payrolls and more workers have gone back to their country homes and don’t count in the unemployment stats.

Every economic statistic coming out of the Chinese Communist government is suspect. The real economic indicators are China’s shrinking purchasing of raw materials. The real indicator is the way they juiced the stock market to fund debt of government-owned corporations by sucking out some of the $7 trillion held by Chinese savers.

According to a Morgan Stanley analyst, 90 million retail investors outnumber the 88 million members of the Communist Party. However, two-thirds of Chinese investors lack a high school diploma.

And that’s why one investor relied on advice from a hairdresser, why a college student invested money his parents gave to get married, why an artist invested his life savings.

It’s not a new story that rubes are being fleeced in the stock market. What’s new is China’s unprecedented interference and political investment in the stock market.

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