China – The Good, The Bad and The Ugly

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china - good bad ugly

After a relatively “calm” 2-weeks or so for Chinese shares, brought on by massive-scale Central Bank intervention in the markets, this Money once again saw a return to huge losses.

Despite trillions of Yuan being made available to the Chinese version of “The “Plunge Protection Team” (PPT) the Shanghai Composite still fell 8% on Monday … the biggest single day plunge in share prices, not only during the recent rout, but ever since the huge declines of 2007.

The losses continued on Tuesday, furthering the decline to fully 11%

The falls brought fresh doubt to the Chinese authorities claims to be able to stem the outflow.

Wednesday though, did see an unusually “smooth” rally in afternoon trading into the close, a smooth ride which many analysts put down to the not-so-hidden-hand of the Chinese PPT.

Despite all of this Ugly news though, there has been some merely “Bad” news!

The news that is merely “Bad”, a sort of silver lining if you will, is that the exposure of the Chinese population to the recent losses is quite limited, with who who are as yet even involved in Stocks & Shares, running at around just over 8%.

One view then, is that with in excess of $20 trillion dollars having been generated in recent years, and still sloshing around in the Chinese economy, that these funds will have to go somewhere, especially with interest rates having been slashed so many times in the last year, in an attempt to take the heat out of the economy (haven’t we heard that story somewhere before?).

Hence many who missed out on this last years sudden “surprise” Bull Run rally, may already be eyeing the ongoing rout, and viewing it as a “bottom feeding” buying opportunity.

This factor in and of itself then, aside from the deep pockets of State and Central Bank interventions, seems set to act as some sort of limiting factor, buffering the downside.

There is another “limiting factor” that is worthy of note though. This one will perhaps help protect the rest of the world’s economy.

It is that the rest of the world has a limited exposure to Chinese share markets. This too may help prevent the worst fears of some analysts from coming to fruition.

Hence the “China Syndrome” meltdown forecasts of some of the more pessimistic talking heads, are hopefully wide of the mark.

“The China Syndrome” by the way, was a 1979 fictional thriller about an incident/accident at a nuclear power plant in Los Angeles.

Part of the film’s cult status and reputation, stems from the fact that is was released just 12 days prior to the the “Three Mile Island Incident”.

The term “China Syndrome Event” then – a term that was never intended to be taken literally of course – described a “worst-case scenario” outcome, where a “melt through” of a nuclear plant would tunnel “all the way to China”.

Some though, perhaps mostly those who invested in Chinese stocks at their very peak, prior to the June collapse, may well be wondering quite how far down share prices might “tunnel” before they finally halt!

But, just as the China Syndrome was based on a fanciful notion, so too Chinese share prices will finally their equilibrium, as the country understandably adjusts, from their early role as “the planet’s global factory”, to something of a more balanced position.

But, that natural and to-be-expected “re-balancing” of China’s role in the world, has not been the only factor that has led to the recent turmoil, far from it.

In a recent article here at Q Wealth Report, we spoke briefly of the devastating impact that “Margin Trading” had had on the Chinese financial markets.

Hence one of the other factors that has had a major impact on market volatility, has been the imprudent and abusive use of debt. It has in many ways, had a more devastating impact on share prices than might at first be supposed.

Hence perhaps at this point it’s worth briefly taking a closer look at the whole “Margin Trading” phenomenon in China.

They say that “a picture speaks a thousand words”, and so to save probably a thousand words of explanation here, we refer your attention to the following graphic.

margin debt

As you might have guessed, the sudden appearance of that red line, indicates the moment in mid 2010, when the Chinese authorities finally relented, and allowed the practice of Margin Trading.

From a standing start, Margin Trading (essentially the borrowing of money, for the sole purpose of leveraging it in order to speculate on stocks and shares) went parabolic.

Anyone who has ever read about what happened in 1929 Crash, will know that Margin Trading of course, always comes in a package, along with its Evil Twin … Margin Calls!

In turn, Margin Calls, as any leveraged trader knows, result in a surge of desperate, “sell at any price” selling, when the inevitable reversal in share price direction arrives.

So … is China replicating the mistakes of the USA in 1929?

Well, not quite.

At its peak in the USA in 1929 … 40 cents of every dollar used to buy shares in New York, was in the form of leveraged Margin Trades, and we all know where that ended!

Hence perhaps why the NYSE figure above, has stubbornly remained below a conservative 3%, even in their own prolonged Bull Run.

Having said that, in many ways the US has simply transferred much of their leveraged activity into Quadrillions of dollars worth of Derivatives, so they hardly need crow about their own “prudence”!

So while China is undoubtedly going through some intense volatility and losses right now, it can hardly be said to be unexpected, given the source of much of the initial gains.

China then, along with every other country in the world, awaits with baited breath, to see how markets react to this upcoming Fall, to see whether or not it will be accompanied by an altogether other kind of fall.

But if it does come, as many pundits predicting, it won’t just be “China’s fault”; the systemic problems with our global economy run far deeper that that.

As of right now, the signs are not great, but we will be taking an over view of the opinions of some commentators, in upcoming Blog posts.

 

To Your Secure Financial Future, as always

Kris Karlsson

Banking Expert

The Q Wealth Report Team

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1 thought on “China – The Good, The Bad and The Ugly”

  1. Translation the consequences for the Australian economy are potentially severe. The situation in Australia is exacerbated by the dwindling space that Australian policy makers have to respond to negative global shocks, such as a slowdown in China.

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