It's time to discuss another of those items that no one in the USA seems to discuss. Today's overlooked story is the Chinese stock market. The Shanghai stock market index declined by more than 3% today. That means that in the last two weeks, the Shanghai market (China's version of Wall Street) has declined by about 20%. That is a move of gargantuan proportions.
There's plenty of reason for the decline. First, the Shanghai market had soared during the last year. Indeed, even after the 20% decline, the Chinese market is up for the year. Some view the decline as just getting rid of some of the excesses in valuation that had built up during the boom. Second (and more threatening), the Chinese have incredibly high amounts of stock bought on margin. In China, many of the companies on the stock market have major shareholders who do not trade their stock. The shares that are left to trade freely are called the float. In the latest figures available, margin debt in China was nearly 9% of the total value of the float. To put this in context, in the USA, margin debt is something just under 3% of the float and many think it is too high. So what does this high margin debt mean? When stock values fall by 20%, the amount of the debt remains unchanged but the value of the collateral goes way down. For those investors whose portfolios decline by more than the 20% (and there are many of those), there may be a margin call. In other words, the lender may ask for repayment of the margin loan. That means that the investor has to sell the stock which backs up the loan in order to have the cash to repay the debt. More stock sales mean lower prices. Lower prices mean even more margin calls. This vicious cycle was one of the reasons for the American stock market crash in 1929 and margin debt has been strictly regulated since that time to avoid a recurrence. In China, however, they have been loosening the reins on margin debt rather than going in the other direction. Third, the Chinese economy is no longer booming. We still have the phony statistics that the Chinese put out to show that all is well, but the real numbers show otherwise. China's purchases of commodities have dropped (as has world prices), and the main reason why less raw materials are needed is less demand for the finished product.
If you read the news today, all the economic stories are about Greece. That's an important story, but Greece is tiny compared to China. If the Chinese market is really in meltdown mode, it could be a storm that few in the world could weather. Just think of the consequences for the USA if the Chinese were to dump their holdings of US treasury bonds on the market.
There's plenty of reason for the decline. First, the Shanghai market had soared during the last year. Indeed, even after the 20% decline, the Chinese market is up for the year. Some view the decline as just getting rid of some of the excesses in valuation that had built up during the boom. Second (and more threatening), the Chinese have incredibly high amounts of stock bought on margin. In China, many of the companies on the stock market have major shareholders who do not trade their stock. The shares that are left to trade freely are called the float. In the latest figures available, margin debt in China was nearly 9% of the total value of the float. To put this in context, in the USA, margin debt is something just under 3% of the float and many think it is too high. So what does this high margin debt mean? When stock values fall by 20%, the amount of the debt remains unchanged but the value of the collateral goes way down. For those investors whose portfolios decline by more than the 20% (and there are many of those), there may be a margin call. In other words, the lender may ask for repayment of the margin loan. That means that the investor has to sell the stock which backs up the loan in order to have the cash to repay the debt. More stock sales mean lower prices. Lower prices mean even more margin calls. This vicious cycle was one of the reasons for the American stock market crash in 1929 and margin debt has been strictly regulated since that time to avoid a recurrence. In China, however, they have been loosening the reins on margin debt rather than going in the other direction. Third, the Chinese economy is no longer booming. We still have the phony statistics that the Chinese put out to show that all is well, but the real numbers show otherwise. China's purchases of commodities have dropped (as has world prices), and the main reason why less raw materials are needed is less demand for the finished product.
If you read the news today, all the economic stories are about Greece. That's an important story, but Greece is tiny compared to China. If the Chinese market is really in meltdown mode, it could be a storm that few in the world could weather. Just think of the consequences for the USA if the Chinese were to dump their holdings of US treasury bonds on the market.
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