The 6.5 per cent plunge by the Shanghai Composite Index last Thursday appeared to have been sparked by the People's Daily, the official newspaper of the Chinese Communist Party, warning about an asset bubble. An alternate theory was that a number of brokerages had tightened their requirements on margin trading, ostensibly after prodding by state authorities. This is revealing - if there is a more confusing hybrid socialist-capitalist country in the world than China, it is hard to think of one. The vertigo-inducing doubling of the largest Chinese stocks in the past year, coupled with the tripling of its start-up stocks, has been partly because the state media conferred its blessing on the stock market last August and has repeatedly exhorted everyone from migrant workers to retirees to invest in it. The most charitable explanation is that Beijing was trying to move people away from their obsession with property. It has ended up with an even more undesirable result of turning the stock market into something with the dynamics and appeal of a casino.
Beijing is now in the uncomfortable position of wanting to talk down two asset classes - property and stocks - while being unnerved by the prospect of steep falls of the sort seen last Thursday. This leads to policy that looks like one step forward, one step sideways, one step back. Little more than five weeks before Thursday's fall, for instance, the Chinese securities regulator rolled out rules that banned so-called umbrella trusts providing cash for margin lending and also imposed limits on margin trading for over-the-counter stocks. The regulator promoted the use of short selling as well. The following day, the China Securities Regulatory Commission was forced to issue a statement saying that the measures weren't "intended to encourage short-selling, let alone depress the market." It called on market participants not to "over-interpret the measures." The problem is that the cheerleading from the state over the past few months can't be undone. From Guangzhou to Beijing, the state media have gone so far as highlighting stories of villagers investing successfully in the stock market. Indeed, two-thirds of Shanghai's stock investors have not completed high school. But you do not need to be a Warren Buffett to make the right bets when the Chinese government is talking up the market. The pity is that Beijing is undermining the successful reforms of Xi Jinping's first couple of years in office which saw a freeing of rates banks charged for loans as well as a move to allow Chinese investors to invest in Hong Kong. The former British colony which is governed by a separate administration and separate regulators and has notably not been affected by the irrational exuberance on the Shenzhen and Shanghai stock exchanges.
If the stock market were to crash, it would dampen consumer demand in an economy awash with overcapacity and given to dumping everything from tires to toys on its trading partners. And although Beijing's control over its population is much more secure than in most dictatorships, a crash in the stock market, after citizens were encouraged to invest, might well shake its authoritarian communist-capitalist paradigm.