A model of Chongquing built from coins. Photo: STR/AFP/Getty Images
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The wild ride on China’s stock-market rollercoaster is far from over

China's admirers like to compare its Communist leadership to a meritocratic mandarin caste whose governance skills outstrip anything on offer in the west. But with £2trn wiped off the mainland exchanges in July, the picture is more complicated.

The scale and speed of China’s growth make it easy to overlook the way in which the country is still feeling its way forward. It may have become the world’s second-biggest economy, with 7 per cent growth officially reported for the second quarter of the year this past week, but it is still plagued by problems of expansion, from disparities in wealth to a huge environmental fallout. Recent weeks have thrown up another example of the dangers that can arise from insufficiently considered leaps into the future.

Admirers of China like to compare its Communist leadership to a meritocratic mandarin caste whose governance skills outstrip anything on offer from the fumbling administrations of western democracies. Yet the convulsions of the mainland stock markets over the past month – in which £2trn ($3.2trn) was wiped off the mainland exchanges before prices stabilised towards the end of the first week in July – show the authorities in a rather different light.

One might ask why Beijing was so intent on developing the country’s stock markets on the back of individual retail investors, many of them lacking experience in such techniques as margin trading, in which you buy shares using money borrowed from a broker. It might have been better from the start to have mobilised big institutional players, such as pension funds. The government, however, decided to encourage the growth of the largely retail markets in Shanghai and Shenzhen, in the hope that companies would raise capital there rather than seeking bank loans.

This was considered to be part of the modernisation of the financial system at the heart of the ambitious reform plan laid out by the Communist Party at the end of 2013. The programme claimed “the dynamism of the market” would be harnessed to move China towards a new economic paradigm, replacing its outdated reliance on the cheap labour, cheap credit and booming export markets that have fuelled growth for the past 37 years. The stock market was viewed as a way of achieving a more efficient allocation of capital and of mobilising household savings into corporate funding.

As it happened, there was a lot of cash looking for a home as a result of the downturn in the property market, historically a magnet for middle-class savings, and a squeeze on high-risk financial products outside the mainstream banking system. On top of that, the relaxation of rules on margin trading acted as an incentive to buy shares.

The result was a runaway bull market from 2014 onwards, with the number of individual investors increasing from 70 million to 90 million and the volume of officially sanctioned margin trading rising from £40bn to £220bn. Once the boom was under way, the government moved in with the second part of its strategy to develop China’s stock markets, introducing measures that facilitated the initial public offerings (IPOs) of 25 companies. Given that prices of newly floated firms often double on the first day of trading, the IPOs are hugely oversubscribed.

There were two snags. The first was that the boom assumed bubble proportions on the back of margin trading. The second was that so much cash was tied up in these IPOs that there was little left over to sustain demand for other shares. For short sellers, who make money by betting that prices will drop, it was a clear signal to act. Once they did and share prices fell, the remorseless logic of margin trading kicked in, with investors forced to sell their shares to repay brokers’ loans. The result was a 32 per cent drop in prices on the Shanghai Composite Index in less than a month.

The government moved in with supportive measures, including buying by state institutions, but these were initially unable to stop the slide. Only after increased support and adjusted margin requirements and with half of the quoted shares suspended did the market find a bottom and start to rise.

The impact of the gyrations can be overstated. Of the 90 million account holders, 30 million are estimated to hold only one or two stocks and to trade infrequently. The size of the stock markets is still quite small compared to the overall economy; the two are usually not co-related, so the broader impact of a downturn is limited. In addition, the Shanghai market is dominated by shares of state-backed companies that are less affected by stock movements than private firms. Even in the depths of the early-July decline, the Shanghai Composite Index was 70 per cent above its level a year earlier. Fears of a firestorm that would cause a crash in China and affect other economies were overblown.

Still, the turbulence that resulted in day-to-day swings up to the permitted limit of 10 per cent is likely to continue in short, sharp bursts. What is more important is the impact on the government’s broader economic policies. These face a great deal of opposition from vested interests that have done well out of the old economy and are facing not merely the challenge of change, but also the unrelenting anti-corruption campaign launched by Xi Jinping. They are likely to seize on events on the exchanges to point to the dangers of relaxing controls in the last major Leninist state on earth. Indeed, conspiracy theories on Chinese websites suggest that they may have been behind the short selling.

That will put the reformers on the back foot. Xi is a leader who ranks the preservation of the Communist Party first; if reform seems to present problems with maintaining authority and ensuring social stability, it will take second berth. That would have long-term effects on China’s evolution and may well be the most important aspect of this summer’s market roller coaster.

Jonathan Fenby’s book “Will China Dominate the 21st Century?” is published by Polity. He tweets as: @JonathanFenby

This article first appeared in the 16 July 2015 issue of the New Statesman, The Motherhood Trap

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Theresa May is paying the price for mismanaging Boris Johnson

The Foreign Secretary's bruised ego may end up destroying Theresa May. 

And to think that Theresa May scheduled her big speech for this Friday to make sure that Conservative party conference wouldn’t be dominated by the matter of Brexit. Now, thanks to Boris Johnson, it won’t just be her conference, but Labour’s, which is overshadowed by Brexit in general and Tory in-fighting in particular. (One imagines that the Labour leadership will find a way to cope somehow.)

May is paying the price for mismanaging Johnson during her period of political hegemony after she became leader. After he was betrayed by Michael Gove and lacking any particular faction in the parliamentary party, she brought him back from the brink of political death by making him Foreign Secretary, but also used her strength and his weakness to shrink his empire.

The Foreign Office had its responsibility for negotiating Brexit hived off to the newly-created Department for Exiting the European Union (Dexeu) and for navigating post-Brexit trade deals to the Department of International Trade. Johnson was given control of one of the great offices of state, but with no responsibility at all for the greatest foreign policy challenge since the Second World War.

Adding to his discomfort, the new Foreign Secretary was regularly the subject of jokes from the Prime Minister and cabinet colleagues. May likened him to a dog that had to be put down. Philip Hammond quipped about him during his joke-fuelled 2017 Budget. All of which gave Johnson’s allies the impression that Johnson-hunting was a licensed sport as far as Downing Street was concerned. He was then shut out of the election campaign and has continued to be a marginalised figure even as the disappointing election result forced May to involve the wider cabinet in policymaking.

His sense of exclusion from the discussions around May’s Florence speech only added to his sense of isolation. May forgot that if you aren’t going to kill, don’t wound: now, thanks to her lost majority, she can’t afford to put any of the Brexiteers out in the cold, and Johnson is once again where he wants to be: centre-stage. 

Stephen Bush is special correspondent at the New Statesman. His daily briefing, Morning Call, provides a quick and essential guide to domestic and global politics.