China’s Planned Economy and Its Bubbles

China’s stock market fell by 29% since its June 12 peak. Social media has become fired up. One of the most popular keywords is ‘4000 points’ on China’s various social media platforms.

When I searched on Baidu.com (China’s Google) [NASDAQ:BIDU], the top suggested search keyword for ‘stock’ is ‘stock market suicide’.

I have already spent four days in Beijing and things are happening at a very fast pace.

There is the plunging stock market in China and there is also the Greek issue. At the same time, the Chinese government seems to be doing everything it can to stabilise the local markets.

The latest move sees China’s 21 major brokers buy and hold no less than RMB120 billion (US$19.62) on blue chip-based exchanged traded funds. This amount will account for 15% of the total net assets.

The brokers will not sell stocks they held on 3 July and will buy more as long as the benchmark Shanghai Composite Index is below 4,500.

There is no doubt that these actions will further distort the true value of assets in the China market.

I am writing this article on 5 July, Sunday. After weeks of severe asset deflation, a weekend like this is a good time for people to clear their heads and meditate on what has happened.

I have read articles from the Chinese social media space and everybody is quick to point fingers.

Retail investors are blaming the foreign institutions for suspected shorting activities on the mainland market.

They are also blaming short sellers on the mainland. Of course, there is also a lot of discontent towards the government.

People believe the government should have done more to help the market.

I have talked to some retail investors in China, who make up 80% of the market. The first words they usually say are ‘I can’t believe it broke through 4,000 points’.

It seems people had a firm belief that the correction was going to be a minor one and it wouldn’t drag the whole market to lower than the 4,000 point psychological threshold.

But it did…

There is no doubt that leverage has been a problem.

I have long suspected that leverage would play a big part in causing major havocs. I was right to think that.

After all, the last bubble in 2007 also saw leverage playing a large part in building up an incredible bull rally. It also amplified the domino effect of position folding when everyone sold.

I have been tracking the situation very closely in the last month.

I issued a risk warning to our New Frontier Investor clients some three weeks ago. I basically said there was an increasing chance of a freefall on the Chinese market.

I was right. But how did I know?

I didn’t know. I simply looked at the numbers that I have been publishing since 2014 and concluded that a sustainable level on the Shanghai market would be 4,250 points in 2015.

My calculation was produced by using variables such as economic growth and interest rate.

There were plenty of people outside China who believed the market would implode.

Bill Gross, the co-founder of PIMCO, was one of them. Investment firm Credit Suisse also issued a warning stating that the market was overvalued by 25%. This was slightly higher than my own calculations.

But you didn’t even have to do that much number crunching to reach these conclusions. If you had looked at the speed and scale of the China rally, combined with how badly the economy is doing, you would intuitively have known that this would not likely last.

And you would have been right.

They are mad

I have been fairly active on my on Wechat (China’s Facebook) account. I have mainly talked about the tactical trading implications in such a volatile market.

Such as, the market is now far lower than the fundamental level for 2015. Therefore, I am telling buyers to get ready to enter.

However, something struck me yesterday. I suddenly realised the bubbles in China have been caused by no other than China’s planned economy itself.

I know that probably doesn’t sound like much of an epiphany, but bear with me.

The overcapacity situation, the property bubble, the stock market bubble and the coming entrepreneurship bubble are all results of government interventions in the market.

China operates on a planned economy system in which the government sets the policies in the market.

The only problem is, it distorts market activities and prices. At the end of the day, there is ALWAYS a big bubble.

‘So what there is a bubble? Markets operate in cycles anyways’, you may say.

You are right. However, the problem is bubbles tend to make a small amount of people rich at the expense of the society.

You have seen it happening. China’s overcapacity made those factory owners very rich and poisoned China’s environment beyond repair.

The property bubble has made property ownership nothing but a dream. However, property developers made a lot of money out of it.

The stock market bubble has left many in debt or bankrupt. There is a feeling of betrayal for those who entered into the market late.

Now, the government has called upon the brokers, who are partly owned by the government and partly owned by private capital, to stabilise the market by purchasing assets.

To me, it is sadly immoral. Because firstly, prices need to correct to reflect the true value of assets instead of being supported by artificial means; secondly, it is immoral to use private institutions and private capital to solve a systemic problem.

In the past two years, Premier Li Keqiang has called upon everybody to pursue entrepreneurship. He wants China to become a country of ‘makers’.

I am sure that is going to end up in a bubble somehow. I am also sure that it will produce more bad quality products than it will produce innovation.

One of my friends in Beijing answered Premier Li’s call.

He, a Taiwanese industrial designer, has decided to open his own coffee shop in Bejing.

I personally believe that is among the worst ideas for a business in Beijing, because there is too much competition.

For my friend’s sake, I hope I am wrong.

After all, I am responsible for encouraging him to quit his job and start his own business. I was thinking more along the lines of product innovation or technology.

Instead, he opened a coffee shop…

So much for a country of ‘makers’.

Ken Wangdong,

Emerging Markets Analyst, New Frontier Investor

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