People have been asking me a lot lately about the impact of the Chinese stock market crashing. My answer has two parts…
First, China’s stock market is completely typical of what a crash or bubble bursting looks like. Bubbles don’t go straight up and collapses don’t go straight down. They’re jagged.
Check out this stock chart of the Dow Jones Industrial Index from 1928 to 1932.
Source: Credit Writedowns
The stock market crashed in October 1929, but you can see the bubble growing before that. You’ll also see the market went straight up in a bubble then it broke.
Then it went up a little bit, broke down a little again, then went back up slightly, then broke down again.
The bottom did not come in October 1929 or even 1930 or 1931. The bottom was in 1933. It took four years for the stock market to collapse. It went down over 80%.
Here’s my point: the worst is not over in China.
If you know anything about Chinese culture, they love to gamble. To them the bubble became a big casino and, of course, when it was going up it felt good and everyone seemed like a genius.
But now it’s popping. The market won’t come rallying back either. That’s not how bubbles work.
The second thing I tell investors who ask me about the Chinese stock market is this: what market?
There’s no market left in China. Soon after the crash, the government suspended close to half the stocks on the Shanghai Composite Index from trading. The market was open, but if almost half of the stocks are not trading, do you really have a market? I don’t think so.
What’s more, the Chinese government told institutional investors they couldn’t sell stocks for six months. You can only be a buyer, not a seller. The government has also banned short selling and has put together a multi-billion dollar rescue fund.
This is a façade of a market. What’s left is government manipulation.
Suckering the public
The stock market bubble in China grew out of the country’s ongoing credit crisis. Prior to the stock market crashing, China had a massive debt pyramid that was collapsing. I explain all of this in chapter four of my book The Death of Money.
It was an enormous mountain of bad debt from provincial governments and corporations. You had holding companies where one corporation had some cash and the other corporation was broke. The one with the cash would lend money to the one that was broke, take an ‘IOU’ back and pretty soon they were both broke.
What is the solution to the credit crisis?
Well, you can write off or restructure bad debts, which is what they’re doing in Greece. But the Chinese had a better idea. They decided to sell stock to the country’s suckers.
The government got all of the corporations in China that were going broke to go public. Then, they got the average Chinese citizen to invest.
Many of these people were not financially sophisticated. But the Chinese government’s solution to bad debt was to sell stock to a lot of people who don’t know any better and suck them in.
In a way, it succeeded beyond their expectations. All of a sudden, every proverbial shoeshine man in China was saying ‘buy stock’. It has turned extremely ugly for them.
This is why the elites are getting their money out of China as fast as possible. This is something I noticed four years ago.
All you have to do is go to Melbourne, Sydney, Vancouver, New York or Paris to see it. One of the things you’re bound to notice is that the Chinese are buying up all the luxury apartments.
Why are the richest, best connected, most powerful people in China buying up luxury digs all over the world?
The answer is they want to get their money out. These expensive properties effectively function as offshore bank accounts.
So what does that tell you about China’s economy? It tells you that the fundamentals are terrible, which is what I’ve been saying all along.
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Your big payoff for a little homework
If you have any exposure to the Chinese stock market, now is the time to sell.
You should look at your portfolio and see what’s inside. You may have exposure to China without realising it. For example, in your super fund you may have some BRICS (Brazil, Russia, India, China and South Africa) exposure.
Your broker or your employer may have recommended one of these when these funds were first opening. These kind of funds have been popular.
But which is the biggest emerging market? China, of course.
To be sure you’re not exposed, you’d have to look at the super fund’s offering document. Perhaps they have some Chinese stocks in there.
Try to find out the specific companies the fund exposes you to. You could check online for your particular fund. If you don’t have much luck with this, you may have to call your super provider.
This exercise will take a little time and you’ll have to do some homework. But it will pay off if you find that you have some Chinese stocks buried in your portfolio.
As the Chinese stock market drops further, you’ll be glad you checked.
Analyst, Strategic Intelligence
James G. Rickards is the strategist for Strategic Intelligence, the newest newsletter from Port Phillip Publishing. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He is the author of The New York Times bestsellers Currency Wars and The Death of Money. Jim also serves as Chief Economist for West Shore Group.