The Cause and Future of a Massive Chinese Sell-Off

In a period shorter than a month, the Chinese market has lost over 3.6 trillion in value, which is greater than the GDP of France. Many see this as mimicking the 1929 U.S. stock market crash. Also, this plummeting of equities is beginning to seep into surrounding Asian countries. The cause of this sell off? Simply, millions of average Chinese investor dumped lent funds into the market. The prices, correlating with this buying spree, were then severely over inflated. What happened next can easily be explained as a cycle of panic caused by leverage investing.

The equity markets fell, the Chinese citizens sold off shares to cover these losses on lent money, and the cycle continued on as people panicked. At its peak the extent of leveraged investing amount was around seven hundred billion dollars. The stock market in China contains 80% percent “retail investors”. The U.S.? Around 54%. The massive effect is quite obvious when taking these percentages into consideration. Why are these percentages so vastly different? Last year, the Chinese government encouraged the “Chinese Dream” of a society wealthy and prosperous. Part of this dream was to encourage all citizens to be involved with stock market. “We must deepen economic system reform by centering on the decisive role of the market in allocating resources….” — President Xi Jinping

What will happen in the future? It will most likely continue to get worse. The Chinese government has been desperately attempting to halt the free-fall. The People’s Bank of China has attempted many different modes of action. Banning short selling and cutting rates are a few examples. However, Banks such as Citi sees the fall worsening. Only one fourth of the people who instituted leveraged investing are completely out of the market. As stated above, the cycle of panic will remain in constant. However, it is not a completely negative story.

Chinese banks are more heavily relied on for financing than the equity markets. Also, it is important to take into consideration investors who were in the markets around April will still make a small profit due to the massive upswing of the Shanghai composite before the crash. The first half saw a sizable gain of 14% for the Shanghai, compared with a .2% gain in the S&P 500 this year. The government is promising a plan to save the diminishing value of the market. It pumped 120 billion yen into different brokerages to make sure the market maintains its stability. The government is confident that this ailing market will stay afloat, but it sinking is becoming inevitable.