China's Stock Markets Are Collapsing Again — And No One Knows What the Government Will Do

After three weeks of heavy intervention from Beijing, China's stock markets unraveled once more on Monday, with the Shanghai Composite Index falling 8.5 percent — the steepest decline since 2007 and the second highest one-day decrease in its history.

The tech-heavy Shenzhen Composite fell nearly as much — 7 percent — and the drop would likely have been worse without China's limit of 10 percent on rise or fall in equities. More than half of all stocks on the Shanghai exchange hit their downward limits, including blue chip companies like China Life Insurance and China Shenhua Energy. The oil giant PetroChina, the Shanghai index's most heavily weighted company, fell 9.6 percent.

Chinese stocks had rebounded over the past several weeks after a precipitous crash that saw Shanghai equities fall by more than 32 percent from their June peaks, wiping away more than $3 trillion in wealth in the process. Prior to the retrenchment, stocks on the composite had risen more than 150 percent, and Shenzhen's Index tripled over the past year. Those upsurges were tied in part to a rise in margin trading, as millions of Chinese — including many first time investors with little formal education — availed themselves of loans to ride the upward wave. Even as many economists termed the exorbitant rise in equity valuation a bubble, Chinese state-owned media outlets for many months continued to encourage citizens to put their money into the exchanges.

As prices stabilized this month, analysts cautioned that the turnaround was brought about in large part due to myriad interventions from Beijing, many of them unorthodox. Others called into question the market's lasting viability given the still excessive valuations of many companies. Even during the short-lived recovery, hundreds of companies kept their shares frozen — an option Beijing offers, but which prevented investors from unloading and de-leveraging investments in those companies.

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When Chinese stocks reached their recent nadir, Communist party officials ruled that shareholders, executives, and managers owning more than five percent of a company's publicly-traded shares would not be able to sell any holdings for six months. The government stopped the listing of new IPOs, and promised cash infusions to brokerages as part of an effort to stabilize stocks. The total money spent to directly prop up the market is unknown, but is believed to total tens of billions of dollars.

Chinese regulators and state media issued reports of "malicious" sellers who were trying to manipulate the market, and threatened to prosecute them. What the manipulation meant in practice was never quite clear — some perceived it as referring to anyone selling while prices were falling — but China's Securities Regulatory Commission urged citizens on Monday to call a hotline to report such activity.

"The market stabilized then went up for one reason: The government intervened very heavily," Patrick Chovanec, managing director of Silvercrest Asset Management and a former professor at Beijing's Tsinghua University, told VICE News. "I think a lot of domestic investors said either 'I will buy,' or 'I will just not sell because the government will make sure the market goes up.' All throughout this there were the rumblings about arresting malicious sellers, which kind of cast a chill over people."

Monday also saw the release of disappointing economic data on industrial profits and manufacturing sector weakness, but many analysts pointed to concerns that the Chinese government was readying to withdraw support for the markets as the cause for the fall. Indeed, most of the day's declines occurred in the afternoon, hours after the release of the economic indicators.

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"After three weeks there were some questions people had about whether the government is going to stop buying, and if they are going to stop buying, then maybe its time to get off that elevator, and that translated into a selloff," said Chovanec.

If the rebound was driven largely by Beijing's emergency policies and the nebulous threat of prosecution, the government's next steps could determine how the country will approach the markets in the future.

"If they intervene and just take over the market, which is the only surefire way to stop it [falling], they effectively wreck it in the long term because everyone begins to expect that's what the government will do," Dwight Perkins, professor of political economy at Harvard University and an expert on the Chinese economy, told VICE News. "Therefore, it won't be a market, it will be people speculating against the government's willingness to bail them out."

Perkins said the Chinese economy surely could withstand a reversion to more reasonable stock valuations, but the optics of such a fall — not necessarily the underlying financial toll — may continue to drive Beijing's decision making.

"At this point, it's more of a political judgment than a financial one," said Perkins.

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Even if carried out haphazardly, China's move to have more of its citizens invest their savings in the stock market is not without reason. Though the country's stock exchanges are by no means the most transparent among the world's largest economies, they are considered less opaque than the debt issuances on which Chinese companies have long relied to finance their activities, and the loans that investors have used to buy up property. Until now, many Chinese regarded the debt-ridden housing market as the preferred means to secure appreciating assets.

Though the use of margin lending could mean that many of those who bought stocks in the last several months are deep in the hole, the Shanghai composite is still up 15 percent since the start of the year, and more than 75 percent over the past 12 months. But analysts say that means stock prices could continue to fall, especially if Beijing is seen as becoming more of a neutral actor.

Follow Samuel Oakford on Twitter: @samueloakford