The current unprecedented drop in the Chinese stock market threatens the global economy. However, many economists put forward a different version with an analysis of the causes and consequences of Chinese depression. According to some explanation, the crisis in China is similar to the crisis in 2008 in the United States, and its main cause lies in derivative securities (Walker). According to another opinion, unwise legislation was the main cause of the crisis (Yao). However, the reaction of Chinese society was the catalyst that has created a crisis out of a normal situation, forcing tension and, as a result, creating panic. To prove the thesis, investigation of the causes of the crisis, the process of its flow and effects is needed.
The Reasons for China’s Stock Market Fall
China’s economy, growing rapidly and steadily for the last few decades, entered the most serious crisis of the time. It has started about two years ago when China adopted a package of laws that encourage the purchase of shares of local companies by private individuals. It is the first reason for the beginning of the market growth. The market reacted positively to this: the stock went up. Hundreds of millions of Chinese who had any surplus funds were stimulated to gambling (Warner).
The second reason is that the stock market has been filled with a private currency that only spurred the growth of quotations. Companies of different sizes and activities lined up to IPO, to meet the growing demand with new and new shares (Warner). Third, when investors began to run out of their own funds to purchase the shares rising in price, a massive margin trading has begun. It is a kind of exchange operations when the shares are bought on credit, which is constantly increasing with the growth of purchases (Warner). In the growing market, an investor becomes an owner of more and more assets without allocating his own funds. However, when the market falls to a certain level, all the shares involved in margin trading are either subjected to immediate sale or the investor should repay the debt, adding his own funds to the appropriate account. In general, the richer the investor is on a growing market, the greater debt he takes on the declining market. So, when the market started to decline, a lot of people became saddled with debt.
Thus, the adoption of the relevant legislation initiated a process of the Chinese stock market growth. However, it was the initiative of individuals that has spurred the growth of the stock market, filling it with the private currency. The further mass reaction of society has increased investment in debt money. Therefore, it can be concluded that under the favorable circumstances (legislation), public reaction has defined further development. The further process of crisis flow also should be examined.
The Process of Flow and the Behavior of the Society in Growth Stage
Approximately for a year, the growth trend of the market was positively stable (plus ratio at the argument of the trend graph). Chinese markets rose in price by 150 percent, enriched with the money of those who invested in the market at an early stage (Walker). The faster the market grew, the more Chinese people went into debt to buy additional shares. Various investment and financial companies, various funds and other institutional investors were engaged in similar activities: a game in the growing market has become a national sport. In China, the shares and quotes were discussed by bartenders, taxi drivers, petty clerks, and even students.
Banks, where people stood in lines for loans to buy shares, freely and willingly handed out money on the security of the same growing stock. The rate at 20% per annum did not frighten anybody – if the shares rise by 150% a year, then there is no problem (Walker). The banks had to borrow more money abroad – their funds instantly were used for loans by hundreds of millions of newly minted stockbrokers. As a result, China’s total foreign debt reached a fantastic index of 250% relative to GDP (Walker).
Obviously, rapid market growth was forced by society. Expectations of society generated further growth in the market and created a favorable environment, increasing the volume of investments. However, this process ended up with effects which will be further investigated.
On June 12, 2015, there was a sharp (six percent) collapse of quotations at the major stock exchanges of the country – in Shanghai and Shenzhen (Yao). Roughly the same thing happened in Hong Kong. Thus, the reason for the fall of the markets has also become a psychological reaction of the big players. Some of them decided to lock in profits at the same time. Thus, society has created a panic; hundreds of millions of Chinese tried to save money and rushed to sell the shares at the same time, which further crippled the market.
Minor, but gradually increasing panic has started on the stock exchanges. As a result, the Chinese stock markets have lost in the price of a $ 3.2 trillion (about 30% relative to the peak) for four weeks, which is equal to almost two of India’s GDP (Yao). The further fall, which many hoped to, didn’t happen. One of the conditions of margin trading is a mandatory sale of shares if they fall below a certain level. Huge volumes of shares were forcibly sold at a low price, leaving the owners with huge debts to banks and brokers, instead of profits. As the required sales even stronger blew to the market, it continued to fall.
The Chinese government began to help markets. First of all, they tried to neutralize the panicky rumors about the state of the economy and the stock markets and started an investigation into the first traders. Beijing completely prohibited new IPO, cut the discount rate to flood the market with liquidity, suspended shares trading for 745 most impaired large companies, lifted restrictions on the purchase of shares of pension, insurance companies, and created a “rescue fund” with assets of $ 20 billion, intended to buy rapidly becoming cheaper stocks to delay the fall in their prices (Walker). However, it didn’t manage to help as the scale of the disaster was much more serious. For example, at that moment shares were sold for $ 60 billion a day on the Chinese exchanges, so the 20-billion bailout fund would be enough to stabilize the situation only for a few hours (Yao).
The situation could have been fixed by the National Bank of China if it had entered the market with the equivalent of hundreds of billions of dollars. At least it would have reassured investors that resonated to the reaction of the society. However, in order to do this, The National Bank of China would have had to print out a huge amount of yuan, which would have inevitably led to a sharp depreciation of the national currency and had reduced the chance of turning the national currency into the regional one, and then the global reserve one.
In the meantime, the crisis moved to the next level. The massive bankruptcy of private investors, who had lost all their money with devalued shares, put increasing pressure on banks every day. Loans were not returned. To make matters worse for the banking system, in most cases, the same stocks were collateral in lending. Even if it was possible to sell them, the full amount wouldn’t be returned. Moreover, Chinese banks had their own debts to foreign counterparts. If there were problems with their repayment (and it would be very difficult to avoid that), then the entire banking system of the country would be threatened (Walker).
Without properly working banks further investments were not possible. Obviously, the main crisis effects have been completely created by panic reactions of investors and society. However, China’s problems stopped to be purely Chinese.
Effects of the Crisis on External Economics
The role of China in the world economy is so large that it is even difficult to imagine how a slowdown or a recession in China will affect the world. The fallen stock market hit the emerging Chinese middle class in the hardest way, which, basically, carried their own and borrowed money to a stock exchange. Its poverty will lead to a tremendous reduction in domestic demand and imports of goods of medium and high price category. Not only Chinese manufacturers will suffer, but also the Europeans, Americans, and Japanese oriented to hundreds of millions of Chinese consumers (Neate). For example, it can be assumed that the hard times are waiting for the French winemakers – China is the number one market for them.
The decrease in the production in the major economic centers hit the producers of raw materials who provided this production as well. The cooling down world economy will need less oil, steel, coal, wood and other things. This would harm the economy of such countries as Russia, Iran, and Venezuela, completely aimed at the export of raw materials. For example, the further decline in oil prices against the background of the Chinese crisis is expected (Neate). The same applies to the price of steel: the stagnation of many Chinese companies will significantly reduce the demand for valves, pipes and steel structures.
Waves from the Chinese stock market crisis have already begun to disperse around the world. In August and September 2015, when it became clear that the Chinese government’s measures do not help to halt the decline in the markets, stock prices fell worldwide. And the closer a stock exchange was to China, the greater was the effect. In New York, it fell by one and a half percent, in Tokyo – by three, in Hong Kong – by more than five (Neate). Traders around the world are not very optimistic and expect the Chinese leadership to implement resolute measures to revive stock markets. Meanwhile, China continues to move toward a full-fledged stock exchange collapse, which could lead to a chain reaction: the financial, banking, the economic crisis that hit the economy in the region and, as a result – the whole world.
Thus, the adoption of relevant legislation in China gave a start to a swift rise of the stock market, which can be attributed to the reaction of both large investors and the middle class. The mass reaction of the Chinese society spurred the growth of the stock market, created a build-up of investments in debt money. Thus, a positive rapid growth of the market was supported by the catalytic reaction of society. The expectations of society generated further growth in the market and created a favorable environment for that. Later, the expectations of the society, as well as a psychological reaction to the fixation of profits by large players, created a rapid market decline, a crisis not only in China but also in the external economic environment. Thus, the reaction of the Chinese society acted as a catalyst for the crisis, which confirms the thesis put forward.