One investor shows the strain in a stock exchange hall in Nantong, Jiangsu province, during the recent week of turbulence. Photograph: ChinaFotoPress/Getty
The numbers are mind-boggling. Ten days of falls on the Shanghai stock exchange resulted in losses that exceeded the GDP of Mexico. And 12 million Chinese citizens who opened share-trading accounts in May were nursing potentially ruinous losses. Margin trading – speculating on the stock exchange with borrowed money – increased five-fold in a year to 2.3tn yuan (£230bn).
While Europe’s focus has been the crisis in Greece, the Chinese stock market has been gripped by panic. The value of shares went up by 150% in little more than a year, then fell by 50% in just a few weeks.
Fearful that China in 2015 could find itself in the history books along with Dutch tulips, the South Sea Bubble and the Wall Street Crash, the government in Beijing stepped in to halt the rout. It cut interest rates. It banned large shareholders from selling stock. It used public money to buy equities. It allowed trading in more than half the quoted companies to be halted.
Panic over, then? That’s certainly what some China experts believe. They argue that the impact of the boom-bust in shares will have negligible impact on the real economy. Capital Economics, for example, notes that the rise in share prices did not lead to higher consumer spending, so why should the fall in share prices lead to lower consumer spending, particularly since most of the losers are high-net-worth individuals who can afford to take the hit?
Holger Schmieding, chief economist at Berenberg, says the stock market plays little role in funding investment in China. This, he adds, is just one of the “usual panics and manias to which young financial markets are even more prone than established ones”.
This optimistic assessment could well be correct. After all, the US suffered many boom-busts in the 19th century and they failed to arrest an upward trend that turned an agrarian economy in 1800 into the world’s biggest industrial power by the outbreak of the first world war.
Keynes once wrote: “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.” China, if the optimists are right, is not a casino and the speculation is froth.
Naturally enough, there is an alternative view, which is that the false and disorderly stock market is indicative of a deeper malaise, and that the current state of China is little different from the US in the years before the financial crash of 2007. Both appeared strong, both used inflated asset prices to stimulate growth and disguise fundamental weaknesses in the economy. Alan Greenspan dealt with the fallout from one burst bubble by inflating another.
Something similar has been going on in China, where the response to the global financial crisis was to build inefficient industrial plant and infrastructure that was not really needed, while at the same time using cheap and over-abundant credit to boost property prices.
Russell Jones at Llewellyn Consulting says periods of asset price excess are most serious when combined with a credit boom, and that China is the most obvious current example of such a phenomenon. Jones says the risk is that the Chinese authorities struggle to contain the stock market turbulence with the result that broader indicators of business and consumer confidence decline and GDP growth drops below the 7% target. There would, he adds, be a good chance that neighbouring countries, many of them also displaying bubble-like tendencies, would be affected.
The Chinese authorities won plaudits for their handling of the 2008-09 crisis and may well emerge from this period of turbulence with their reputation intact. They will be helped by the fact that China runs a trade surplus, has strong public finances and has massive reserves. Even so, the lesson of history is that the worst crises are those where excessive credit has led to excessive leverage: investors throw caution to the wind and borrow money in the expectation that asset prices can only ever go up.
This lesson holds true not just for the 2008-08 crash but – according to a 2010paper by an economic research body, the the National Bureau of Economic Research – for the whole era of modern finance capitalism. The authors of the paper studied the relationship between asset prices and the performance of the economy in 17 countries over 140 years and found that what turned a bit of irrational froth into something really nasty was when the irrational exuberance was combined with plenty of easy credit.
This is where things in China start to look a bit worrying. The Bank for International Settlements, the body that represents central banks, has developed a set of indicators to assess whether countries are at risk of a financial crisis. One is whether the ratio of credit to national income (GDP) is more than 10% higher than its long-term trend. A second is whether real (inflation adjusted) share prices are more than 40% above their long-term trend. A third is whether property prices are more than 10% above their long-term trend.
The results for China are not good. The credit gap rose from 12.7% to 14.2% in 2014. The equity gap remained only just below the 40% threshold following the boom in share prices in 2014 and early 2015. And the real property price gap was 10.5% in 2014, albeit down from 23.7% in 2014.
China’s leaders clearly have a problem. They understand that their country’s growth model has to change and become less reliant on investment. Consumer spending has fallen from 50% of GDP – low by western standards – to 35% since Deng Xiaoping began his reform programme a little more than three decades ago. Moving to a model where growth is slower but of higher quality is not easy. As Bob Swarup of advisory firm Camdor Global, has noted, to maintain growth rates at the current target of just over 7% while returning household consumption to 50% of GDP within a decade would require consumer spending to rise by 11.5% a year.
The task is complicated because China’s authoritarian regime is fearful that economic distress will fuel political unrest. That’s why there is always the strong temptation – even for a reformist administration like that of the premier, Li Keqiang, to resort to the old growth-at-any-price ways when things start to look a bit dicey. As they do now.