China's stock market is a high stakes game of 'chicken' – Business …

BySuzanne McGee american, australia, black, canal, chinese, country, federal, festival, japan, nanjing, president, reuters Comments Off

REUTERS/China DailyA Chinese soldier trains a dog by skipping rope at a military base in Nanjing, east China’s Jiangsu province January 28, 2006.

On one side there are the individual investors, who are in the midst of what may be the greatest wave of panic-driven selling we’ve witnessed since Black Tuesday, when billions of dollars were lost in a single day of trading on the New York stock exchange. On the other side: the Chinese government. Worryingly, there’s some evidence that the rest of us are stuck in the middle.

The average Chinese investor had been all too eager to participate in the speculative frenzy that sent the Shanghai Composite Index from only 2,000 points in July 2014 to a peak of 5,200 a little more than a month ago, responding to hints from government officials that stocks were cheap. But financial literacy is largely Awol in mainland China, and what passes for “investing” usually involves rapid-fire trading based on tips or rumors, rather than long-term asset allocation and strategic decisions. Forget financial literacy – nearly 6% of new investors’ households weren’t literate by any measure, according to one survey.

While we tend to be driven by short-term considerations too, these Chinese speculators make the typical US investor look like Warren Buffett. Given the size of China’s population, that wave of speculation is enormous – as many as 800,000 new trading accounts could be opened in a single day, while over the course of the past year the stock market created $6.5tn in paper wealth, sending valuations to fresh highs even as the economy stumbled.

That of course is why, when – as happens with all bubbles – something happened to make someone pause and say “Wait a second, this is absurd” and start to sell, the fallout was equally violent: a decline of 8%, of 14%; a string of losses that so far has caused some $4tn in market value to simply evaporate in less than a month.

Enter the Chinese government. China’s communist leaders declared back in the 1980s that “to get rich is glorious” and set the country on a path leading away from a managed economy. The fairly explicit quid pro quo for a lack of democracy is that the single-party system will ensure that China remains prosperous. Now that an estimated 90 million Chinese citizens probably are sitting on outsize portfolio losses, the selloff presents a direct challenge to the leadership of China, President Xi Jinping and his colleagues.

Thomson ReutersAn investor looks at an electronic board showing stock information at a brokerage house in Nanjing

Unsurprisingly, they have combatted the selloff ferociously. Short selling? Limited, as the state press hints that it’s unpatriotic. The main pension fund for the country’s civil servants will invest 30% of its assets, or $145bn, in stocks. The Shanghai and Shenzhen cut trading fees by 30% to try to prevent any slump in trading activity that might follow the losses. The government has launched a $120bn market stabilization fund, suspended IPOs (in case there is too little demand and the deals fail, further damaging confidence in the markets), and has banned insiders like CEOs and board members from selling stock in their companies for at least the next six months. China’s sovereign wealth funds are emerging as big buyers.

Now the two sides are staring each other down – and there is no guarantee that the government will manage to prevent further bloodshed. Indeed, there’s the likelihood that we will see more days like Monday in which the Chinese market nosedives, causing other global markets to follow suit. It’s only logical: after all, the Shanghai composite index may have had its biggest one-day loss in more than eight years this week, but it’s still trading at 3,789, well above the 2,000 or so where it was a year ago. There are plenty of profits left to vanish in another wave of selling, and a manipulated market isn’t likely to instill long-term confidence in investors. Allowing investors to take out housing loans to purchase stocks isn’t exactly something that is going to encourage prudent, responsible financial decisions – but that’s just what the Chinese government is doing, as part of its efforts to halt the short-term carnage.

All this will be painful to watch, especially if you happen to have allocated a quarter of your retirement funds to a China exchange-traded fund, or you happen to be one of those folks who gets nervous whenever the S&P 500 and the Dow Jones Industrial Average embark on another terror ride.

There are plenty of pundits taking to the airwaves to tell us why we don’t need to worry about the giant game of high-stakes chicken under way in China’s stock market right now, but I’m not convinced by their optimistic “don’t worry, be happy” perspective.

The optimists argue that while China’s economy accounts for about 16% of global GDP, its stock market is relatively insignificant, being only about the size of that of Japan. Most American investors don’t have much direct exposure to Chinese stocks in their portfolios. So far, so good.

But that’s the tip of a very, very large iceberg. There are many more ways in which what’s happening in China today could affect our financial futures for years to come, given the importance of the country in the global economy.

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Consider, for a moment, that events in China have already sent investors fleeing to bonds as a safe haven once more. Looming on the horizon is the September meeting of Federal Reserve policymakers, at which point Janet Yellen, the Fed chair, and her colleagues will consider raising interest rates for the first time since before the 2008 financial crisis. It’s at least conceivable that the uncertainty triggered by events in China will cause them to once again delay the inevitable rate hike.

Then there is the commodities market, where China has long reigned supreme. To the extent that China’s stock market woes reflect (or trigger) problems in the country’s economy, that’s going to put even more downward pressure on the already-struggling prices of crude oil and base metals, like copper. That’s already happening, and weighing on the economic outlook for resource-rich nations like Australia.

Then there are the US companies that in recent years have made a bigger effort to penetrate China’s domestic market. Fast-food chains like McDonald’s and Yum! Brands’ KFC are only the most visible of those pursuing Chinese consumers – but if those consumers are hit by a massive stock market selloff and don’t have the money to spend on treats like pizza or burgers, look for sales to fall. At the other end of the spectrum, the Chinese are massive consumers of luxury brands.

The impact isn’t confined to what happens within China. The Chinese are big travellers and outspent those from anywhere else when visiting top US destinations like New York and Los Angeles. They also buoy property values overseas, snapping up both commercial and residential properties – and it’s a fairly safe bet that some of the wealth fuelling those purchases has come from stock market gains.

REUTERS/Barry Huang A rock fan gestures as he crowd surfs during a performance at the 2012 Strawberry Music Festival at Tongzhou Canal Park in Beijing April 29, 2012. The festival will be held from April 29 to May 1.

Then there is the long-term fallout on the economy. At the very least, a slump in the amount of activity in the financial services industry will take a toll on the pace of economic growth: depending on who you believe, financial services contributes between 1 and 1.5 percentage points to China’s 7% growth rate. There’s also the uncertainty of what happens next, following such massive intervention on the part of the government to prop up stock market valuations at high levels – does it lead to less foreign investment, entrepreneurship and innovation, as confidence that the government won’t intervene if it doesn’t like the outcome dwindles?

We’re lucky. We are – or should be – more financially literate than our Chinese counterparts. We’re not being encouraged by our government to borrow against our homes to buy stocks at lofty valuations. While we are exposed to some risk, and undoubtedly will face a lot of turmoil as the overly complacent US market keeps getting jolted by events across the Pacific, we have the luxury of treating the events as a learning experience. Here is a great example of how not to invest.

This article originally appeared on guardian.co.uk

This article was written by SUZANNE MCGEE from The Guardian and was legally licensed through the NewsCred publisher network.

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China's stock market is a high stakes game of 'chicken' – Business …

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Suzanne McGee