Post a Comment On: China Matters

Take the money and run...

That’s what appears to have been behind the crash of the Shanghai stock market on February 27.

In early February, Time did a good job of describing the liquidity-fueled stock bubble in China, which looked just like the last stock market bubble in China, and the one before that.

Last year 2.4 million investors began trading stocks through the Shanghai exchange, a 250% increase in new accounts. That's an average of about 7,000 a day, a flood of fresh blood from san hu (as the Chinese call small investors) that is making seasoned traders nervous. "When you see shop assistants and taxi drivers racing out to borrow money to buy stocks, you've got trouble," says commodities guru Jim Rogers. "That's the market sucking in a whole lot of neophytes priming to get slaughtered."


When that article was written, the average P/E ratio on the Shanghai Stock Exchange was 45, compared to 18 for the NYSE.

And it had gone up since then, with the index crossing the 3000 mark and setting a new record on the first trading day after Chinese New Years’.

To my mind, there are only two kinds of people who continue to pour money into an overvalued market like this: cretins and criminals.

The cretins never know when to stop.

The criminals, on the other hand, know when a good thing is about to come to an end.

Some observers apparently thought that the rumor of an impending capital gains tax was enough to end the party.

I tend to attribute the crash to reports of an impending government crackdown against illegal bank loans i.e. bank loans taken out for ostensibly for business and capital construction purchases but diverted to stock market speculation.

This is probably as close to a smoking gun as we’ll get, from China Daily on January 30:

China's banking regulators have banned commercial banks from giving loans for stock investment and to investigate and call in all loans suspected of being used for such investment.
The China Banking Regulatory Commission (CBRC) would dispatch officials to examine loans at all commercial banks after the Spring Festival, which will fall on February 18, said an official with the China Banking Regulatory Commission, who declined to identified.

A crackdown right after Chinese New Year.

Just when the market crashed.

How about that.

The first thing the banks do when they hear about a possible audit is to try to call in suspicious loans and clean up their books; and that would be the signal for the speculators to realize their gains and get out of the market.

As to why the loss of 8% in market capitalization on a highly speculative bourse with minimal foreign exposure would give the New York Stock market the heebie-jeebies: it would be a dismaying indication of the tangential bad news that U.S. traders were looking for to confirm their own pessimism.

If I were in the U.S. markets, I would worry less about a much-needed $100 billion correction in Shanghai, than I would about the absolutely catastrophic news that the OMB was correcting its growth estimate for fourth quarter 2006 U.S. GDP from a heartening 3.5% to a dismal 2%.

That’s an overestimate of 75%, representing a contraction in anticipated GDP of perhaps $50 billion for the quarter, with a commensurate reduction in profits translating into a shrink in market capitalization of perhaps $200 billion based on real world—as opposed to speculative—valuation.

And it’s a sign that the U.S. is continuing to plod into a recession instead of pulling out of one.

For China, on the other hand, the crash is good news for everyone except, inevitably, its mismanaged banks, which have probably accumulated a fresh inventory of funny paper for their bad debt portfolios.

Fewer loans are written, macro control of the runaway economy is strengthened, inflationary pressures are reduced, the hemorrhaging of money from productive to speculative endeavors is staunched, and taxi drivers and shop assistants learn a salutary lesson about the risks of capitalism.

The big money players, I suspect, didn’t get skinned.

They took the money and ran—away from the stock market and back to the bond market and banking system.

That’s something I suspect doesn’t bother the government one bit.