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Spring 2015: markets in China are booming. Share prices went up 150% over one year. In the two previous years, the government did everything it could to motivate small investors to purchase stocks. More than 30 million new trading accounts were opened during the first five months of 2015. The boom was such that some individuals quit their jobs, sold their homes or borrowed heavily to be able to invest. “Interest rates were lowered to facilitate loans, and brokerage firms were encouraged to offer margin financing to their clients,” said Tomasz Bielinski, a researcher at University of Gdansk who studied the Chinese bubble.
At the height of the crisis, there was as much as 2 billion yuan (286 billion Swiss francs) in loans, four times higher than the previous year. But on 12 June 2015, the euphoria came to a brutal end. The Chinese exchanges fell drastically. In early July, the Shanghai exchange lost 30% of its value. On 24 August 2015, it dropped 8.5% in a single day. The catastrophe would lead to one of the most significant state interventions ever attempted for a stock market.
A group of state companies, nicknamed the “national team”, was quickly established. “Their mission was to purchase shares from the 200 or 300 struggling companies that dominated the exchanges,” said Thomas Gatley, expert in Chinese markets at research institute Gavekal Dragonomics. “Between June and July 2015, this state team spent nearly $300 billion.”
During that same period, big investors – those holding more than a 5% market share in a company – were forbidden to sell their shares for six months and listings were suspended. “To top it off, the state declared a moratorium on trading for 1,300 companies, which is equivalent to 45% of the market,” said Bielinski.
Furthermore, some 200 people were arrested in the following months, including short-sellers, journalists covering the bubble bursting and a hedge fund manager, Xu Xiang, who was accused of contributing to market volatility by betting on forward stocks.
TRANSACTIONS UNDER SURVEILLANCE
Recently, Beijing intervened twice more. In October 2017, leading up to a crucial congress for the Communist Party, China began to monitor all transactions exceeding one million yuan (143,000 Swiss francs). The goal was to avoid any market volatility during the Communist Party congress, as the government wanted to project a stable image. Investors who were making risky ventures received warnings from the government. An investor based in the province of Guangdong received such a warning since he purchased and then sold $325,000 worth of shares in a chain of shopping centres. A client of Haitong Securities, a brokerage firm based in Shanghai, received a 24-hour trading suspension after selling $1 million in shares of a large bank.
In October of last year, Beijing became involved in the markets yet again
In October of last year, Beijing became involved in the markets yet again, when it became apparent that many companies had offered their shares as a guarantee in order to obtain loans. The poor performance of the Chinese markets in 2018 put these companies in danger. Approximately $613 billion worth of shares would be at risk, according to Bloomberg. “Rather than deploying a national team, this time the government chose to create local units in charge of making funds available to support struggling companies,” explained Gatley. Comprising institutional players affiliated with the government, these units are currently operating in Beijing and Shenzhen.
China has a tendency to intervene to such an extent in the markets because it is terrified that they will fail. Approximately 85% of investors are individuals, who have often invested their life savings in the markets. “The government wants to make sure that these people don’t lose too much money, since that could lead to political instability,” said Bing-Xuan Lin, finance professor at the University of Rhode Island. A decline in prices could also affect the real economy, creating even more uncertainty for the Communist Party.
But this type of government activism does come with consequences. “This situation leads to distortions and unhealthy speculation: if you’re an investor and you know that the state will always bail out struggling companies, then you’re betting not only on the companies that will likely create value, but also on government interventions,” said Lin. Listed companies will develop risky behaviour, such as taking on excessive debt, since they know that the government will always be there to save them.
And when the markets are virtually suspended, like in summer 2015, the companies that should pull out of the markets cannot, and those that should go public are unable to do so. Shareholders, who are told to sell their shares, end up losing confidence in the markets. “In the future, investors will no doubt put their money elsewhere,” said Bielinski.