# The China Bubble



## room305 (20 May 2007)

Shares listed on the Shanghai exchange (accessible only to Chinese citizens) continue to explode in price and volume. In six months volumes have gone from $5 billion to $50 billion a day, eclipsing the rest of Asia including Japan. The index is up over 40% this year (despite a 9% sell-off in February) and up nearly 250% since 2006. 

Here is one snippet from an article [broken link removed] (emphasis mine)



> Millions of first-timers are getting involved in the frenzy as Shanghai's main market gauge continues to post eye-popping gains.
> 
> After watching Chinese stock prices gallop upward for months, Ding Xiurui wanted a piece of the action.
> 
> ...



I don't have an online reference for this as it was emailed from friend in Beijing. It appeared in the LA times.



> Eager Chinese grab bull market by the horns
> As the Shanghai index soars, exuberant small investors are buying in, often on credit.
> By Don Lee
> Times Staff Writer
> ...



The whole setup is eerily like the Nasdaq in 1999. Heavy investment by unfamiliar retail investors hoping to make easy money. Remortgaging and borrowing to place everything in the stock market. No perception of risk and an unerring belief that the government can prevent the market from crashing. Jumping several psychological milestones at once - despite a quadruple run-up to 4,000 in a short space of time investors are already talking about hitting 8,000 by year end. This reminds me of the "Dow 36,000" nonsense during the Nasdaq bubble.

At this stage I think it has gone too far for the Chinese government to do anything about the bubble, it is only a matter of determining what the likely fall out is for the world markets ...

EDIT:

Just for comparative purposes on Wednesday the turnover of some of the world's major exchanges

US - $122 billion
Shanghai - $49 billion
Japan - $26.9 billion
UK - $29.4 billion
Malaysia, Singapore, Australia, India, Hong Kong, S. Korea, Thailand, Taiwan, Indonesia, New Zealand and Vietnam combined - $16.5 billion

Just how monstrous is this bubble?


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## rock3r (20 May 2007)

Assuming the worst happens, China's economy is still structurally aiming for higher growth.

Millions of Chinese who thought they were middle-class and that capitalism is painless may get a rude awakening. In the medium term, the Chinese government won't change its fundamental course based on this relatively small minority who, even in a full democracy, would bear little clout.

But China is booming because it's the cheapest option for global manufacturing. A stock crash which impoverishes only Chinese citizens will not change this fact.


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## room305 (20 May 2007)

rock3r said:


> Assuming the worst happens, China's economy is still structurally aiming for higher growth.



Apart from North Korea, are there any countries that are "structurally aiming" for lower growth?



rock3r said:


> Millions of Chinese who thought they were middle-class and that capitalism is painless may get a rude awakening. In the medium term, the Chinese government won't change its fundamental course based on this relatively small minority who, even in a full democracy, would bear little clout.



This would be the "relatively small minority" of approximately 95 million people invested in the Shanghai stock exchange. Nearly 7% of the entire population of China or about half of the people over there that can afford to purchase a microwave oven. As for bearing "little clout" - 2,000 people rioted when the average bus fare increased by 50 cent. The Chinese government reported 23,000 separate incidents of "mass protest" last year. So I would hazard a guess that there were twice as many riots as reported. Let's see how much clout they have when they lose everything they own.



rock3r said:


> But China is booming because it's the cheapest option for global manufacturing. A stock crash which impoverishes only Chinese citizens will not change this fact.



It isn't the cheapest option for global manufacturing but that's probably beside the point. These citizens aren't involved in a card game, they are purchasing shares in real companies. They are doing so with money borrowed from Chinese banks. They are securing these loans against their own homes. When the market collapses so does the capitalisation of these companies. In many cases, the municipal government is still the majority shareholder.

Most investors in China that I know, have done so predicated on a burgeoning consumer class in China and the opportunities this will present for Western and Chinese companies in terms of new markets to sell to. How much of a set back will this receive if half of China's middle class lose their homes and see their pensions wiped out in a stock market collapse?


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## z108 (20 May 2007)

Why all the optimism among ordinary Chinese that the Government will prop up the market until after the Olympics?
I can imagine the closer to 2008 the more nervous everyone will get and all hell will break loose. And what effect would a plunge in Chinas' stock market have on the world economy if any?


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## rock3r (21 May 2007)

An investment crash-led consumer recession in China will not be sufficient to cause an actual overall recession. Whether the 7% of China that is middle-class is eating caviar or dogfood will not change the fact that every day of the week hundreds of manufacturing processes are setting up in China after closing down a western operation.

That's what I mean by "structurally aiming" for higher growth: the world economy is such that the vagaries of the Shanghai Stock exchanges will not change that fact that the only way is higher growth.

It's like Ireland in 1995; despite our public transport and health service and a thousand other things being very bad indeed, our economy was poised for 100% growth, mostly because of a tax differential between us and the USA.

In China it's the same thing: the cost differential between manufacturing in China and in the West is massive, and we can expect 100% growth over the next decade or so while that differential exists.


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## room305 (21 May 2007)

Some more choice pieces from an AP article. Again apologies for the lack of a link.



> This year's 50 percent rise in the main market measure, the Shanghai Composite Index, comes on top of a 130 percent increase in 2006. The market shrugged off a one-day drop of nearly 9 percent in late February that set off a decline in stocks around the world.
> 
> On Wednesday, the Shanghai index passed the 4,000-point mark for the first time, and economists say it could break 5,000 in a month. Trading volume Wednesday for Shanghai and China's second smaller exchange in the southern city of Shenzhen exceeded all other markets in Asia, including giant Tokyo.
> 
> ...



How much of China's growth has been achieved through exchange rate manipulation? This manipulation is causing huge inflationary problems and this in turn is fuelling their stock investing mania. China can only tackle its inflationary problems through higher interest rates and a sharp revaluation in the dollar/yuan exchange rate. Doing this risks bursting the stock market bubble and severely dampening its export trade (higher prices).



> That's what I mean by "structurally aiming" for higher growth: the world economy is such that the vagaries of the Shanghai Stock exchanges will not change that fact that the only way is higher growth.



Surely you have just taken one meaningless phrase here and replaced it with another. Though funnily enough, the Chinese government has been voicing its hope for lower growth (8% rather 11% currently) as it fears the economy is starting to overheat.


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## Remix (21 May 2007)

Apparently there is no legal way for Chinese citizens to short the market so without the means to hedge against losses, there will likely be a mass panic to exit from the market in a downturn.

Althought this stock market is isolated I'd imagine the rest of the world is highly vunerable to the fall-out in terms of sentiment.

49 of the 56 countries in the Wilshire Global Index are all up in new territory having just recently hit record highs.


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## rock3r (21 May 2007)

Clearly, there could very well be a bubble in Chinese-only stocks. Which makes sense, as the bulk of the money being made in China is by local subdivisions of multinationals based in liberal democracies.

There's also something of a bubble in Western stocks and shares, arguably. The total market cap of the stocks in the USA is over $20 trillion, and that's roughly thirty times the combined amount of all the profits made in the Land of the Free.


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## room305 (21 May 2007)

rock3r said:


> Clearly, there could very well be a bubble in Chinese-only stocks. Which makes sense, as the bulk of the money being made in China is by local subdivisions of multinationals based in liberal democracies.
> 
> There's also something of a bubble in Western stocks and shares, arguably. The total market cap of the stocks in the USA is over $20 trillion, and that's roughly thirty times the combined amount of all the profits made in the Land of the Free.



I'm glad we agree. The question is not which is a bigger bubble but what the likely fall-out is. It's hard to imagine the rest of the world emerging unscathed.


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## room305 (25 May 2007)

Lest there be any doubt how bad things are, this article provides some insight http://www.financialarmageddon.com/2007/05/bubble_in_chine.html. There are reports of people bringing shopping bags full of cash into brokerages to set up trading accounts due to the unreliability of electronic transactions in China. I can only imagine what the fallout from this will be like. It has to be bigger than the Nasdaq bubble.


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## tyoung (26 May 2007)

what interests me is how to play this bubble. I'm not interested in shorting any of the Chinese ETFs.
I think you should avoid Asia as their markets will be hit hard. I used to think Japan would be a refuge but I now think they will be hit hard. Other Emerging Markets will also be vunerable.
In the equity markets Europe and in particular the US would be the havens. 
If you are really worried the US long bond is the place to be. Otherwise cash.
For myself I haven't put any new money in Emerging markets for sometime. I've being buying the US and Europe markets.
I don't hold any longterm bonds as I can't tell when or if the bust will happen. I do hold some cash which I would hope to redeploy if we get a bust.
Regards


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## room305 (28 May 2007)

From Bloomberg



> Investors opened 362,719 accounts at brokerages on May 24, the fifth straight day the tally has exceeded 300,000, according to figures on the China Depository & Clearing Corp.'s Web site. So far this year, 20.9 million accounts have been opened, four times the amount in 2006, the clearing house's data shows.


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## room305 (29 May 2007)

Having thought about this and considering the amount of coverage it is now getting in the media I am convinced that the bursting of the Shanghai bubble will have little or no effect on Western markets. It was even on Newstalk this morning where the business editor seemed unable to grasp that these are investments for Chinese citizens only, despite Ger Gilroy hinting around the fact.

It may not even have much of an effect on Chinese funds (which are almost certainly invested via Hang Seng or NYSE listed ADRs). It may even spark a rally on Wall Street, as the absence of a reaction causes some traders to wonder what the hell the fuss was about.


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## Afuera (29 May 2007)

room305 said:


> Having thought about this and considering the amount of coverage it is now getting in the media I am convinced that the bursting of the Shanghai bubble will have little or no effect on Western markets. It was even on Newstalk this morning where the business editor seemed unable to grasp that these are investments for Chinese citizens only, despite Ger Gilroy hinting around the fact.
> 
> It may not even have much of an effect on Chinese funds (which are almost certainly invested via Hang Seng or NYSE listed ADRs). It may even spark a rally on Wall Street, as the absence of a reaction causes some traders to wonder what the hell the fuss was about.



You could be right, but then there's always the chance that a huge bust would have a big destabilizing effect politically in China. There's already a lot of bad feeling towards the government and well connected monied classes over there. If such a large amount of ordinary people ended up loosing their shirts, I wouldn't be surprised if there was a rebellion of sorts. I think that the government knows this too and could resort to rash measures such as unpegging the yuan from the dollar to try and recover some of the value for the people there. A soaring yuan would cause deflation in China and let people live better on less, however it would cause hyperinflation in the West. If it all goes pear-shaped in China, it's hard to see how we would be able to continue unscathed.


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## rock3r (29 May 2007)

Afuera said:


> You could be right, but then there's always the chance that a huge bust would have a big destabilizing effect politically in China. There's already a lot of bad feeling towards the government and well connected monied classes over there. .


 
Yeah, they must be really sweating about the results of the next election.

You forget the fact that if there was some type of middle-class rebellion, the Chinese state would simply massacre it into non-existence, and those who don't get killed will spend the rest of their days in captivity fervently wishing they had. 

They could even have a referendum on the issue, as the massacres would all happen in cities and the rural majority could probably be bought off. I mean that literally: the Chinese State has a trillion dollars of reserve assets.

All in all, a mass rebellion has a very slim chance of happening, and none of succeeding.


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## Afuera (29 May 2007)

rock3r said:


> You forget the fact that if there was some type of middle-class rebellion, the Chinese state would simply massacre it into non-existence, and those who don't get killed will spend the rest of their days in captivity fervently wishing they had.


This isn't North Korea we're talking about. There are a lot of western interests in China these days so human rights and environmental issues have become of much greater importance. An outright massacre, a la Tiananmen Square in 1989, would not be so easy to pull off thesedays



rock3r said:


> They could even have a referendum on the issue, as the massacres would all happen in cities and the rural majority could probably be bought off. I mean that literally: the Chinese State has a trillion dollars of reserve assets.


Some of the most violent riots happen in rural areas. I don't think you realize the amount of discontent there is over there. Even small non political gatherings have the potential to get out of hand very quickly as there are so few legitimate avenues for the average Chinese person to vent their frustrations and make themselves heard. The government knows this and has banned many seemingly innocent groups just to be on the safe side.



rock3r said:


> All in all, a mass rebellion has a very slim chance of happening, and none of succeeding.


You've obviously never been to China then. You should know from history that a rebellion doesn't have to succeed to have a widespread effect.


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## room305 (29 May 2007)

rock3r said:


> All in all, a mass rebellion has a very slim chance of happening, and none of succeeding.



The equivalent of a 50 cent rise in the cost of bus fares sparked a bloody riot in one province. There are over 95 million people invested in the Shanghai and Shenzen exchanges. About 21 million people invested this year. Many of these are "all in". Borrowed against their houses, invested their life savings everything. Many are buying on margin to create leverage and thereby increase the potential gains. A 30% or 50% crash could leave them with nothing.

You mightn't be worried but I'll bet the Chinese government is.


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## Afuera (29 May 2007)

room305 said:


> You mightn't be worried but I'll bet the Chinese government is.


Totally agree with you room305 and I think that this is where there is real potential for major problems to develop in China. IMHO the paranoid and controlling government there could easily start panicing once they realize how out of control the stock market is and might end up doing something very rash.


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## Sunny (30 May 2007)

Stock market down 6% yesterday after the government increased share trading to tax to 0.3% up from 0.1% in an attempt to cool the market. This is not going to end well for the Chineese.


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## room305 (30 May 2007)

Reaction on the US futures markets is fairly muted this morning. S&P 500 is only off a mere five points or so.

Even that great political opportunist Alan Greenspan has started talking about there being little reaction to the sell-off on Western markets.


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## Sunny (30 May 2007)

Yeah I notice that. Even the Asian markets seem to have reacted calmly enough.


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## room305 (5 Jun 2007)

Great article pondering this very question here



> ... moving in anything other than baby steps could unleash a storm of social unrest in China. The kind of wealth created by the stock-market boom is pretty much all that legitimizes Communist Party rule these days. The social contract in China now runs along these lines: Give us rising incomes, more things like those people have in the developed economies and a reasonable degree of stability, and we'll let you run the country. If the Communist Party can't deliver its part of the bargain, however, no one knows how much force it would have to apply to ensure its continued hold on power.


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## room305 (7 Jun 2007)

Seems the Chinese investors are unsurprisingly unhappy about developments over there.



> "I knew the market would go down, but I did not expect it would be this fast. After a small plunge, it should go up, but it is not going up," said Madame Wang, a pensioner in her 50s, who put some of her savings into stocks during the bull run.
> 
> "Next time I will remember -- once the market falls, I will sell all my stocks."





> Another disillusioned investor at an Everbright Securities branch in Shanghai's financial district, a woman in her 30s surnamed Xu, said:
> 
> "I used to have confidence in the stock market. But how can I have confidence now that it has fallen so much. I have no more confidence. Even if the government wants to regulate the stock market, it should not be done like this."



Full article here


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## csirl (20 Jun 2007)

In the end of the day, China is a Communist country. Personal wealth does not officially exist. Anything anyone "owns" is with the permission of the Communist Party, which can take it back anytime it wishes. 

Essentially, these people are playing the stock market with money they dont really own, in the sense that we in the west own things. Anyone in China who appears to have wealth, has it because they are in favour with the local communist party. 

Problem for China, is that eventually it will all come crumbling down. The people will want to really keep the wealth they have earned. As appetite for consumer western style goods grows, they'll want the whole package - the western lifestyle - which includes democracy. They'll want more freedom to chose, more freedom to acquire wealth, a more equal society where merit rather than communist party membership gets you on in the world.

China is also very diverse with different peoples in different parts. When it crashes, and the people want freedom, expect it to fraction into various independent countries ala the soviet bloc.


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## room305 (21 Jun 2007)

csirl said:


> In the end of the day, China is a Communist country. Personal wealth does not officially exist. Anything anyone "owns" is with the permission of the Communist Party, which can take it back anytime it wishes.
> 
> Essentially, these people are playing the stock market with money they dont really own, in the sense that we in the west own things. Anyone in China who appears to have wealth, has it because they are in favour with the local communist party.
> 
> ...



What you say is not strictly true but I do follow your sentiment. Yes, indeed the Communist Party in China does wield enormous influence but this influence is waning. It is becoming harder and harder to maintain the wealth disparity that exists between those in the upper echelons of the party and those outside. Eventual it will crumble and the Chinese people will be greatly liberated as a result. Although I'm not sure whether the country will split or not.


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## garretokelly (21 Jun 2007)

May I ask you, does anyone have ideas on why the bubble originated in the first place? Some change in private ownership laws or something?


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## room305 (22 Jun 2007)

garretokelly said:


> May I ask you, does anyone have ideas on why the bubble originated in the first place? Some change in private ownership laws or something?



I'm sure there are a number of different reasons, of varying degrees of importance but here are two ones I can see

- Chinese citizens legally permitted to invest in domestic stock exchanges (from the long side only). This is obviously a new experience and coupled with factors such as a growing economy and a near country-wide love of gambling, led to bubble behaviour.

- Extremely high inflation. Strong growth and currency manipulation (printing Yuan to maintain a peg to the dollar) by government to protect their export industry left citizens needing to protect their growing wealth. Interest rates are still too low and serious restrictions have been placed on investment in property to try and cap a bubble there.


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