History tells us that stock market crashes inevitably lead to greater unwanted consequences. Among the worst examples are the Great Depression in the United States, which lasted for almost a decade, the Asian financial crisis of the 1990s, and most recently, the 2008 financial crisis that called into the question the practices of financial institutions worldwide.
China’s stock markets are suffering their worst crash since the global financial crisis. Trading was extremely volatile up until Thursday July 9, and investors, some of which have lost their life savings, are still unsure about the near future of Chinese stock markets. The root cause of this is that, over the past year, investors have poured more and more into Chinese stocks, despite weak company profits and economic growth forecasts. Individual and retail investors were the most enthusiastic, and eventually the speculative market bubble developed.
The bubble burst on June 12, and since then the Shanghai Composite lost about 30 per cent of it’s value. The comparatively smaller Shenzhen Composite is down 40 per cent over the same period. Chinese stock markets do not quite work like those in the West, as listed companies are allowed to pull their shares off the market, in order to prevent investors selling their stock or buying more while the market is down. In this case, around half of all listed companies pulled shares off the market.
In an effort to desperately control the crisis, the Chinese government has given money to brokerages to buy stocks and has ordered company executives not to sell their shares, in order to prevent illegal short-selling or borrowing of stocks so that they can be sold just as their value is about to fall. Government regulators and security officials are investigating this practice in order to see if it is the root cause of the crisis. Unlike more mature markets, China’s stock market is dominated by small individual investors, who held more than 80 per cent of the shares up to the end of 2014. Their losses are attributed to the gamble investors took by increasing their stakes when prices were high, leading to an unprecedented high turnover. Some lost their entire life savings while betting on stocks, and the nominal wealth of households have clearly decreased.
According to Lei Mao of the Warwick Business School, it is still too early to say how this loss in private wealth will influence domestic demand. However, Mao believes that it is very unlikely that the stock market will gain further momentum and trading volume will shrink. The central bank has cut interest rates to a record low with gold and copper prices tumbling. Economists are worried that stock losses will ripple through China’s economy and cut into consumer spending. The crisis threatens to pass into the broader economy at a critical time when growth is at its lowest level within the last 25 years. Growth in China could fall to a historic low of 4 per cent.
Analysts agree that mainland China’s stock market turmoil will have a profound impact on the future of the nation’s economy, society and particularly, its politics. According to the South China Morning Post, in Hong Kong, China’s market meltdown will delay the nation’s ambitious programme to reform the country’s financial system and state-owned enterprises, after 30 years of market reform. The crisis could result in a strengthening of government financial regulations and supervision, which could impede reform progress.
A political backlash may also occur as the new leadership under President Xi Jinping had been hoping to create a layer of middle-class market investors as a source of political and social stability. Steve Tsang, Head of Contemporary Chinese Studies at the University of Nottingham, added that should stock markets not recover in time, the Xi administration’s efforts:
“to rebalance the economy from one that is investment driven to one that is consumption driven will be pushed back…”
The market failure could undermine the supreme political authority of the ruling Communist Party, whose legitimacy to govern is almost entirely based on its ability to guarantee rising living standards and economic prosperity. Xi’s consolidation of political power is closely tied to how he handles the market meltdown.