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How Big Are The China Stock Market Risks| Behind the Bull and Bear Markets - YouTube
Channel: Lei's Real Talk
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If you have any investments that track the
emerging markets indexes, it is better to
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understand Chinaâs stock market.
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And in this video, weâll share with you
the story of Chinaâs stock market.
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How is it fundamentally different from the
developed financial systems?
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And whatâs behind the past bull and bear
markets?The Foundation of Chinaâs Stock
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Market Gong Zhuming was a former Chinese Communist
Party committee member at the Peopleâs Bank
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of China, Chinaâs central bank.
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He recalled that during a meeting in 1988
with the then mayor of Shanghai, Zhu Rongji,
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his advice to Zhu was quote: âIf (you) raise
capital by issuing stocks, the principal doesnât
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have to be repaid.
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Youâll just need to pay some dividends.â
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Zhu was very fond of the idea of not needing
to repay the principal.
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At the time, CCPâs state-owned enterprises,
or SOEs, had been expanding at a fast pace.
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But the inefficiencies led to losses and liquidity
issues.
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Therefore Zhu convinced the then CCP leader
Deng Xiaoping to approve the Shanghai Stock
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Exchange.
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And in late 1990, the CCP opened both the
Shanghai Stock Exchange and the Shenzhen Stock
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Exchange.
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It seems the main practical reason the stock
market exists has been that, unlike bank loans
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and bonds, there is no required principal
repayment on stocks.
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For the CCP, it would be a great way to help
keep the large and inefficient SOEs afloat.
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And the investorsâ interest hasnât been
a priority.
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So how has the CCP been running the stock
markets?
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Fabricating Financials to Go Public In October
1992, the CCP established the securities commission
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under the state council.
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Zhu Rongji, who was promoted to the vice premier
of China, was the commissionâs director.
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In 1993, Chinaâs inflation was rising.
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Beijing was forced to tighten the money supply,
which caused severe liquidity issues among
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the SOEs.
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After 2 trillion yuan spent on direct funding,
subsidized loans, and converting debt to stock,
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the problem was not resolved.
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Then the CCP directed the SOEs to raise capital
through the stock market.
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And from 1992 to 1994, the number of publicly
traded companies increased from 53 to 291.
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The flood of supply drove the Shanghai Stock
Index down from around 1,000 points in December
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1993 to below 400 points in July 1994.
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To stop the bearish trend, on July 30, 1994,
the China Securities Regulatory Commission,
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or CSRC, announced three measures to save
the stock market, including pausing new stock
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issuance and initial public offerings, controlling
the size of offerings, and allowing the creation
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of more investment funds.
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After the policy came out, the Shanghai stock
index rose 30% in one day on August 1.
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And by September, the index had tripled.
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This was the first time the central government
intervened to stabilize the stock market.
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But, in 1994, about 40% of SOEs were still
running at a loss.
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In 1996, more large SOEs started to go public.
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And to meet requirements, many of them had
to fabricate financial statements.
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Since then, market interventions and fabricated
financials have become notable features of
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Chinaâs stock market.
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Earlier this year, Luckin Coffee was found
fabricating sales to raise money in the U.S.
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But this behavior was not rare in China.
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Covering 600 Billion of Non-Performing Assets
In 1998, Zhu Rongji became the premier of
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China.
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As for the stock market, his policy was that
quote: âThe stock market should serve to
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provide relief to state-owned enterprises
and to expand the joint-stock system.â
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On May 16, 1999, Beijing approved the Six
Suggestions for Further Regulating and Advancing
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the Development of Securities Market.
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The policies include loosened rules for securities
firms and expanding investment funds.
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This led to the so-called May 19th Bull Market.
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On June 10, the central bank lowered interest
rates for the seventh time since 1996.
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On June 15, state media Peopleâs Daily quoted
CSRC vice president Chen Yaoxian commented
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that the bull market was just a recovery,
which further pushed the market higher.
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On the 22nd, the president of the CSRC made
another comment encouraging the public to
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invest in stocks.
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Less than 3 years ago, he warned people about
market risks and discouraged speculations.
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By June 2001, the Shanghai Stock Index reached
2,245 points.
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The bull market did provide the CCP with some
financial relief.
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Between 1999 and 2001, stock trading profits
helped hundreds of securities firms cover
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about 600 billion yuan of non-performing assets.
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In August, China Petroleum & Chemical Corporation,
one of Chinaâs largest companies, completed
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its IPO at 4.22 yuan per share.
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After 20 years, its share price is around
4 yuan at present.
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The bull market was largely backed by the
CCPâs policies and the investorsâ faith
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in the central government.
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The stock valuations measured by the price-earnings
ratio were very high.
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But the companies that raised capital did
not materially improve their performances.
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The loss of trust in the government led to
a bear market for the next five years.
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By June 2005, the Shanghai Stock index had
dropped to 998 points.
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Because Zhu Rongji had led many of the interventions,
some in the field came up with a joke quote:
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âitâs not a bull market.
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Itâs not a bear market.
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Itâs a Zhu market.â
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Playing Trick on Investors In May 2005, the
CCP started trials to reform the SOEsâ ownership
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structures.
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At the time, stocks in the SEOs were divided
into two categories.
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The majority stake owned by the CCP or those
back by it was legally barred from circulation.
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As a result, the SOEsâ managers did not
have to care about how their decisions would
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affect the prices of the publicly traded shares
owned by investors.
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In the long term, this conflict of interest
was not good for investor confidence.
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But changing the rule alone would dramatically
increase the supply of stocks in circulation
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and drive down the prices.
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Therefore, starting June 2005, the CCP announced
a series of policies to increase the demand.
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These included increased holdings by the state-backed
shareholders, lowering the trading related
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taxes, and approval of more new investment
funds.
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The then governor of the Peopleâs Bank of
China, Zhou Xiaochuan, personally encouraged
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speculation by stating quote: âthere are
risks with buying stocks, but there are even
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higher risks with not buying stocks.â
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And the bull market started at the end of
that year.
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In 2006, the stock market was up 130%.
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By the end of 2007, the combined value in
Shanghai and Shenzhenâs markets reached
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30 trillion yuan, ten times what it was just
2 years ago.
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The number of stock trading accounts increased
from 2005âs 77 million to 2007âs 138 million.
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This created an excellent opportunity for
the CCP and its SOEs to cash out.
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By June 2008, at least 12 large SOEs went
public, each represented over 1% of the entire
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market.
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Many existing public companies started to
sell additional shares.
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For example, Citic Group, the state-backed
shareholder of Citic Securities, sold 3.6
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billion yuan worth of shares.
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The Shanghai stock index reached its peak
of 6,124 on October 16, 2007.
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To prevent the market from overheating, Beijing
raised interest rates six times, and bank
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reserve requirements 10 times in 2007 alone.
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The actions to suppress the bubble, the oversupply
of stocks, and the global financial crisis
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together caused the market to crash.
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By October 28, 2008, the index had plunged
to 1664 points, losing 72.8%.
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On November 11, Beijing had to announce a
4 trillion yuan stimulus package.
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The market was up over 7% immediately.
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But the effect of the stimulus didnât last
very long.
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The Shanghai Stock Index only recovered to
around 3,500 points by August 2009.
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Then it started going down again until 2014.
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As the then president of the CSRC, Guo Shuqing,
commented in 2012: âThe days of cashing
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out of the stock market by treating investors
as fools have gone.â
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We can imagine how bad the market was when
the CCPâs top financial regulator makes
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such a remark.
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But has the investors been fairly treated
since then?
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The Market Turbulence that Spread Globally
By early 2014, the Shanghai Stock Index dropped
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to around 2000 points.
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But the CCPâs need to pump liquidity into
its state owned enterprises didnât change.
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Another policy-driven bull market was on the
way.
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In September 2014, state media Xinhua.net
published 9 articles in 3 days to encourage
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the public to buy stocks.
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In November, Beijing opened up a new channel
for foreign investors to invest in mainland
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China through Hong Kong.
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It also made new rules to limit the supply
of new stocks by curbing the sizes and valuations.
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From a monetary perspective, Beijing lowered
interest rates and bank reserve requirements,
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and made it easier for people to speculate
on the market with borrowed money.
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The stimulating policies turned out effective.
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By November 2014, China passed Japan and became
the second largest stock market in the world.
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And the Shanghai stock index went all the
way up to 5,178.19 by June 12, 2015.
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This time was no different when it comes to
giving the state-backed shareholders a chance
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to cash out.
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According to official statistics, from the
beginning of 2015 to July 9, about 70 SOEs
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sold roughly 33 billion yuanâs worth of
stocks.
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Nevertheless, the bubble eventually burst
as soon as the CCP tried to reduce the low
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quality loans given to individual investors.
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The Shanghai Stock Index started to drop on
Monday, June 15.
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It was down to around 2,850.71 points by August
26, losing 45% in about two and a half months.
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Fears in the market had spread worldwide.
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On August 24, the U.S. stocks suffered the
biggest one day fall since 2011.
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The CCP then tried every possible way to stop
the losses.
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It assembled a so-called national team of
securities firms to provide liquidity, arrested
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fund managers Xu Xiang and Li Jianlin for
market manipulation and insider trading, and
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used the state media to maintain investor
confidence.
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But the efforts didnât help much.
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By August 2018, China ceded the second largest
stock market status back to Japan.
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And to date, the stock index has only recovered
to about 3,200 points.
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The Ultimate Winner The stock markets have
their ups and downs.
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And we recognize that many skilled investors
can make money in any type of market.
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But we need to realize that Chinaâs stock
exchanges were not designed to embrace the
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free market.
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Instead, they have been the CCPâs financing
tool to save its corrupt and inefficient state-owned
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enterprises that control Chinaâs economy.
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And when the market isnât going in a direction
it likes to see, the party has not been shy
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to use its state power to exert influence.
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The not always successful interventions have
caused the markets to be driven by the policies
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rather than Chinaâs fundamental economic
conditions.
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As Friedrich Hayek put it: âEconomic controlâŠis
the control of the means for all our ends.
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And whoever has control of the means must
also determine which ends are to be served.â
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The CCP understands that.
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So we wouldnât expect it to give up control
of Chinaâs stock market.
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The regime and its state-owned enterprises
will continue to be the ultimate winners.
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And the average Chinese investors who put
their faith in their government will continue
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to be those paying the prices.
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Whatâs your opinion on Chinaâs stock market?
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Leave your comments below.
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Thank you for watching Unseen Fortunes.
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