China stock market crash explained

(Next Media Online) – China stock markets went into complete meltdown on Tuesday and Wednesday after being in free fall since June 12.

China was already showing signs of a bubble earlier this year. According to Business Insider, about 80 percent of the trading in Shanghai and Shenzhen is done by Chinese individuals, around 90 million retail investors.

To buy shares, these ordinary citizens had to borrow money, a practice known as leveraged investing, which has been possible in the last five years thanks to a more relaxed policy by the Chinese government on margin financing which allowed brokers to lend their clients money to buy stocks, the Washington Post reported.

The high demand for shares, and not the companies doing well, resulted in inflation of share prices to unsustainable levels.

The rally, however, came while China’s economy was slowing down. The cracks in the system began to show when shares in a few famous Chinese companies, among them Hanergy, started to fall earlier this year, Business Insider reported.

As prices began to drop, the investors, instead of covering the fall with more money, sold shares they had previously bought, to recover enough money to pay back what they borrowed and to cover their losses. This large amount of sellers is what is pushing prices down even further and creating a vicious circle that is spreading “panic” around the country.

One out of four leveraged investors has been driven out of market, and more will probably follow, the Business Insider reported.

According to the Washington Post, “more than $3 trillion in share value has evaporated since mid June.”

The Chinese government has taken some measures to restabilize the market, among which are printing money to finance leveraged stock investment; ordering companies who have sold shares to buy them back and ordering state-owned companies and controlling shareholders not to sell their shares.

According to many analysts however the government’s response to the crash is an overreaction.

According to the Economist, China’s economic stability is not really in danger. The reason why the government is panicking is to be found in politics and it’s connected to the credibility and prestige it has invested in the stockmarket.

As for the rest of the world, the majority of foreign investors don’t seem to be worried as foreigners only own about 1.5 percent of Chinese shares. Panic however is spreading fast to other markets and according to Business Insider, it doesn’t look like it will end well.

SOURCES: BUSINESS INSIDER, THE TELEGRAPH, VOX, CNN, MARKET WATCH, THE WASHINGTON POST, THE ECONOMIST, QUARTZ

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