From May 2014 to June 2015 China’s stock markets experienced strong upward momentum; but something unusual was going on compared to previous China bull markets. Leverage was in the mix as never before.
In fact, in the paper I’m highlighting this week from Mr. Guoxiang Song from the Department of Accounting and Finance at the Faculty of Business of the University of Greenwich, it was ‘..the main driver of stock prices [Over the period].’
As the stock markets are becoming more important in China’s financial system they pose a greater systemic threat to the system than in the past and Mr. Song doesn’t mince words in his conclusion about what should now be done; ‘..it is important for China to stop margin trading and commercial banks’ financing for investment in the stock market to prevent a similar bubble from occurring again in the future.’
Why do more ‘rational’ stock markets matter? Irrational markets frightens long term capital, especially foreign long term capital. They also raise the cost of capital and deter local investors from considering the stock market as a good place to roll up their savings.
Mr. Song’s work also highlights that China’s stock markets, when they’re not going crazy, are in fact very rational places and under ‘normal’ conditions do, mostly, what the fundamentals suggest they should. The recent move though looked to him and others worryingly like the U.S. in 1929 and I found this fascinating clip with Irving Fisher from that time which could have just as easily have described China in June this year Irving Fisher on Leverage.
You can access the paper in full at Drivers of the Great Bull Stock Market of 2015 and if you’re interested in what China has done about the leverage situation since June the Shanghai Stock Exchange put out a daily summary which can be found at Shanghai Stock Exchange Daily Margin Balance (non-Chinese readers give the page a few moments to load properly and then concentrate on the figure in the final column which, I believe, is the daily outstanding balance. See how much its come down since June).
Happy Sunday