China: the dead cat bounce?

A few weeks ago, at the height of the panic in the Chinese stock markets, a sour joke was doing the rounds: “Last month, the dog was eating what I eat. Last week, I was eating what the dog eats. This week, I think I’ll eat the dog.” A lot of people have lost a lot of money.

The Chinese government is permanently terrified. It is terrified of climate change, of slowing economic growth, even of a fall in the stock market - of anything that might cause the population to turn decisively against it. When you are running a 66-year-old dictatorship and your only remaining credibility in the public’s eyes is your ability to keep living standards rising, any kind of change is frightening.

How terrified is it? Consider its reaction to the recent sharp fall in the two main Chinese stock markets. China has a capitalist economy, albeit a highly distorted one and stock markets are a normal part of such economies. They go up, they go down, and normally governments do not intervene in the process.

The Chinese stock markets have recently been on a roller-coaster ride. After treading water for years, prices exploded in June 2014. Over the next year, there was a 150 percent average rise in prices on the Shanghai Composite exchange, and almost 200 percent on the Shenzhen. Obviously this was not sustainable, especially since growth in the real economy had been falling for years. A “correction” was inevitable.

It came with a bang, on June 12 this year. Since then, prices have fallen 30 percent on the Shanghai market and 40 percent on the Shenzhen. Around $4 trillion in paper values have been wiped out - but so what? Chinese stock prices are still far higher than they were a year ago. Indeed, at an average of 20 times earnings, they are still overvalued by real-world standards.

Why would any government intervene over this? Some investors will win, some will lose and it will all work itself out. But the Chinese government intervened in a very big way. First it cut interest rates to the lowest level ever. When that didn’t stop the slide in prices, it banned large investors (holding more than 5 percent of a listed company’s shares) and all foreign investors from selling their shares for six months.

Anything and everything to stop the prices from falling, and lo! They did stop. Last week, prices even rose a bit.

This may just be what traders call a “dead cat bounce” - if the price falls from high enough, there is bound to be a little bit of a bounce at the bottom - but that is mainly of interest to Chinese investors. The interesting question for the rest of us is: why did the Chinese communist regime do all this?

Because there are 90 million private investors in the Chinese stock markets. They tend to be older (two-thirds of them didn’t finish high school) and they have been betting their savings on the market - and according to state media they have lost, on average, 420,000 yuan ($67,000) in the past six weeks.

So the regime intervened. This may be because the Chinese Communist Party loves the citizens so much that it cannot bear to see them lose. It is more likely to be because it is frightened that those tens of millions of stock-market losers (who were officially encouraged to invest) will start protesting in the streets. Whether the Chinese regime’s power is secure or not, it certainly does not FEEL secure.

This latest government action is part of a pattern that extends back to the global bank crisis of 2008, after which China was the only major country to avoid a recession. It did so by flooding the economy with cheap money. So few people lost their jobs, but the artificial investment boom created a bubble in the housing market that is now starting to deflate; millions of properties lie empty and millions of mortgages are “under water.”

Sooner or later, this game is going to run out of road. The risk is that China’s road ends where Japan’s thirty years of high-speed growth ended in the late 1980s, with a collapse to 2 percent growth or less and a quarter-century of economic stagnation. China is around the thirty-year point now, and its regime is doing all the same things that the Japanese government did just before the collapse there.