Worry About China, Not Greece

When’s the last time markets reacted positively to anything happening in Greece?

Last week, just 10 days after Greek voters voted against a resolution that would have required stiffer austerity measures in return for a third Eurozone bailout, the Greek Parliament voted 229 to 64 with six abstentions in favor of harsher austerity measures than would have been required if voters approved the resolution.

As The Economist put it, “Grief, psychiatrists say, has many stages, from denial to acceptance; and Greece seems to have raced through them all.” Shanghai

So Greece needs psychiatric help.  That should have been clear years ago.  These are the folks who elected Alexis Tsipras of the wacky extreme-left Syriza Party as their prime minster.

Tsipras quickly found that his socialist machismo wasn’t very effective, given that his country needs billions of euros just to survive.  So maybe it’s not surprising that he and the Greek Parliament caved so quickly.

Not everyone was pleased. Fellow Syrizan Zoi Konstantopoulou, the parliamentary speaker, called it a “very black day for democracy in Europe.”  Since when does a socialist worry about democracy?

But enough about Greece.  Which country should we be worried about? 


Population: 11,300,000

GDP:  $237,590,000,000


Population: 1,357,000,000

GDP: $10,360,100,000,000

Do the math and you’ll find that the population of China exceeds the population of Greece by a factor of more than 120.  Its gross domestic product – if reported GDP is to be believed (which it isn’t) – exceeds that of Greece by a factor of more than 7,634.

China’s Asset Bubble

China’s asset bubble appears to have been pierced, which could have worldwide repercussions.

As we reported last week, the recent swoon in China’s stock market began when the Shanghai market fell more than 2% on President Xi Jinping’s birthday – a day when Chinese investors expected big market gains.

“In most countries, no one thinks there is a link between a leader’s birthday and the market,” The Wall Street Journal reported.  “That such a theory prevails in China reflects the widespread belief that Beijing’s authoritarian government can produce any economic outcome it wants.  Now trust in China’s ability to command and control the economy is faltering.”

The belief in China that the government could control the stock market led many Chinese investors to invest on margin.  Margin lending rose to CNY2.2 trillion (CNY is the Chinese yuan; the exchange rate is currently 6.2 yuan to a dollar) and reached a record 18% of the Shanghai Stock Exchange Composite Index free float market cap on July 3, according to Zerohedge.  The free float market includes all shares held by public investors (it excludes restricted shares held by company officers).

To provide some perspective of the amount of leverage created by all of that margin lending, consider that margin lending on the New York Stock Exchange has consistently been no more than 3% (up from 1.5% in 2012) and on the Tokyo Stock Exchange it’s now less than 1% of free float.

The drop in China’s stock market, beginning after a June 12 peak, wiped out almost $4 trillion in value in less than a month, as investors who borrowed to buy shares had to unwind their trades.

Chinese regulations allow margin trading only for investors with account balances of at least 500,000 yuan; traders who meet those requirements can lever only two times their assets.

“Behind the scenes however,” Zerohedge reported, “a remarkable shadow margin lending system was thriving, as the country’s newly-minted day traders searched for ways around official margin restrictions.

“Backdoor margin facilities included, famously, umbrella trusts and structured funds.  Umbrella trusts were set up like a CDO.  The senior tranches were marketed to depositors who were promised a fixed coupon – what they were not always aware of, was that their cash was then used to finance margin trading in the lower tranches. In short, depositors were sold a fixed income product that wasn’t a fixed income product.”

CDOs, or collateralized debt obligations, you may recall, were widely used in the U.S. during the heavily leveraged period just before the financial crisis.

“Once the meltdown entered its second week,” Zerohedge noted, “China scrambled to prop up the market, unleashing an eye-watering array of stimulus and support measures including rate cuts, liquidity injections, and, most famously, selling bans which stopped just short of threatening to execute anyone found to be engaged in ‘malicious’ activities.”

Reuters reported that the country’s biggest banks have lent 1.3 trillion yuan ($209.4 billion) to China Securities Finance Corp., China’s state-backed margin lender, to support stock prices and stop the market meltdown.

“So far,” Zerohedge wrote, “none of the measures have provided a sustainable solution and now, traders around the world watch the China open as though it were a SpaceX rocket launch – that is, there will be ignition, the only question is whether it will be in orbit in five minutes or whether it will explode in mid-air.”

Essentially, China’s central bank is underwriting brokerages’ margin lending businesses.

What’s happening in China could make the Greece crisis seem insignificant.  The Federal Reserve Board should take note.  This is what happens when central banks and government officials try to control the stock market, rather than letting markets operate freely.

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