Feeling panic in the air, stock market officials called on one of their own to turn the tide.
They gave him a pocket full of cash and a directive – buy until stocks trade higher.
He dutifully stepped onto the floor and began purchasing blocks of blue chip companies at above-market prices. Market participants quickly fell in line, buying up shares and pushing up prices.
This is not a recap of events in China. This is what happened in the U.S. in early October, 1929.
As losses mounted, the board of the New York Stock Exchange sent their Vice President, Richard Whitney, onto the floor to buy blocks of well-known companies. The strategy stopped the Panic of 1907, and they hoped it would work again.
It did… for a little while.
Within two weeks the markets would suffer a devastating rout, on what became known as Black Tuesday. The selling would continue on and off for more than two years, until the Dow Jones had fallen more than 80% when it reached bottom in 1932.
As the Chinese property markets slowed in 2014, investors and speculators turned their attention from condos to stocks. Over the course of a year they pushed China’s main stock index, the Shanghai, up more than 150%.
For months the papers were full of stories of small-time investors jumping into the markets to make a buck. Many of them took out loans to purchase shares.
Under those circumstances, it was only a matter of time before the market imploded.
The Shanghai peaked in early June at 5,178, and then fell dramatically over the next three weeks. By the first week of July, the index was off almost 30% – losing over $2.4 trillion.
Fortunately, the loss was softened a bit because the government had recently changed regulations to keep margin loans outstanding, even as share prices declined. Since investors haven’t been required to meet margin calls by putting up more collateral or selling their shares at a loss, the selling has been orderly so far.
But they didn’t stop there.
In addition to interest rate cuts and lowered reserve requirements, the government also pumped money directly into brokerage firms for the express purpose of making even more margin loans.
At the same time, just as with the stock exchange and Richard Whitney in the 1920s, China’s own government tried to force prices higher by purchasing shares in large companies.
After plummeting 30%, these efforts sent the Shanghai up 2.4%, but then it turned lower again.
Clearly, China is desperate.
Its government needs the markets to hold and go higher. It can’t afford to see its emerging consumer class hit with huge loan losses. If they lose their equity value and owe their margin loans, then untold numbers of investors could be wiped out.
With slowing exports and falling construction, the Chinese have staked much of their future on domestic consumer spending. If mom-and-pop investors carry margin debt for stocks that have plummeted in value, they won’t be able to buy more stuff and drive up the economy.
This might explain why the Chinese have taken their efforts to yet another level.
Not only has the government funneled money to brokerage firms specifically to lend to investors so they can buy more stock, but they’ve also loosened the rules on what type of assets investors can pledge as collateral. Now, the Chinese can pledge their homes when they want to borrow money to make investments.
With the stroke of a pen, Chinese officials have taken the jagged remnants of one asset bubble – stocks – and stitched them to yet another asset bubble – housing.
This goes way beyond funneling money to brokerage firms to lend to investors. If investors pledge their homes and then use the money to buy stock, then any market losses could lead to the selling of shares followed by the liquidation of real estate!
In other words, both stocks and real estate could tank!
If only the economic experiments stopped there. The Chinese government is also buying up thousands of empty homes to sell to the nation’s poorest households. The idea is that this adrenaline will give the property market, and the economy, a good kick. But it completely ignores the effect of aggravating an already existing housing bubble.
At last check, China held $3.73 trillion in foreign currency reserves. The country is well-capitalized, so a stock market crash and selloff in real estate won’t send the nation into bankruptcy or default. But it will hurt when these assets start tumbling.
And the pain won’t stop at the borders.
China is the 800-lb. gorilla in the Pacific Rim. When the country feels pain, all of its smaller neighbors – Japan, South Korea, Australia – share in the discomfort.
As the Middle Kingdom goes through the process of finding a bottom in its capital markets, and potentially a retrenchment in property values, investors should think carefully before they invest anywhere in the region.