Due to extent of government intervention in its own market, many have come to see China’s market as a reflection of its own credibility and reputation. China has taken a more hands-on approach to controlling its market than any other economically significant country in the world. Preceding the crash, China’s state-owned media stations encouraged individual investors to make risky investments using borrowed money. In many cases, the aggregate of their investments exceeded the rate of growth and profits of the companies. In addition, the central government began to slowly loosen monetary policy, eventually lowering lending rates. As a result of China’s heavy involvement in the market, many investors found themselves in an arena rife with moral hazard. Investors were able to make risky bets with the cushion of the Chinese government stepping in to prevent crashing stocks. This “risk-free” environment was able to galvanize soaring levels of investment in the market, creating a bubble in the market despite economic slowdown. In one year, the Shanghai Composite had climbed more than 150 percent.
Once the market had begun to fall, China underwent extreme measures to stop the market from falling further. Despite president Xi Jinping’s expressed desire to make the Chinese stock market a more liberal and globally integrated entity, the Chinese government created and enforced an onslaught of restrictions on the market and its investors. In July, the China Securities Regulatory Commission imposed a 6-month ban of stock sales by major shareholders. In addition, officials threatened to arrest any investor found of short selling, a form of investing that essentially bets against the market. Shortly after, stock prices began to artificially rise again, only to result in China’s largest drop yet, known as Black Monday. Once again, Chinese officials searched for scapegoats to preserve their international reputation. In less than a week, Chinese authorities arrested and questioned 197 people they blamed for “spreading online rumors” that “lead” to Black Monday.
Yet while China scrambled to defend its economy, the response of its citizens has revealed changing ideals. Although government has tried to artificially prop up the stock market and convince their investors of less volatility, the prospect of possibly losing life savings has put many investors into a state of panic. Nearly a third of the country’s individual investors (more than 20 million people) have fled the plunging stock markets. The number of investors holding stocks in the account fell from 75 million in June to 51 million at the end of July. Backed into a corner and scarred by losses, Chinese investors have looked for safer forms of investments. Many have realized that there is nothing stable to be found at home. As ZZ Xu, a Shanghai restaurateur, noted, most Chinese citizens have come to realize that they “can lose a lot of money very quickly.” With the second highest rate of urban household savings (51.5 percent), much of China’s citizens have begun to pour their money into foreign investment, specifically, real estate. Currently, Chinese investors are the leading foreign buyers of U.S. Homes, accumulating a record $29 billion dollars in annual sales. Similarly Australia’s foreign investment review body recently stated that China had overtaken the U.S. as the country with the largest investment from overseas, totaling roughly $19.6 billion dollars. At the end of August, China’s monthly capital outflows peaked at a record high $141.7 billion dollars.
In some contexts, the increase of outward investment is no cause for panic. However, China’s current economic state leaves it particularly vulnerable to this flight. Firstly, this outpour inopportunely arises when China is experiencing slowing growth. As a result, many of the “post-economic boom” businesses that were funded through loans are already struggling to raise capital. Secondly, China is already using monetary easing to prop up its economy, and is thereby left impotent in defending its currency. It comes to no surprise that China subsequently devalued its currency, a common result of capital flight and a last-ditch attempt to strengthen falling exports. Thirdly, the imminent Federal Reserve rate hike will cause even more capital outflows, as investors will be given even more incentive to preserve their wealth in U.S. financial institutions and instruments. Lastly, volatility in Chinese markets and decreasing investor confidence has also scared away many foreign investors. On Aug 25th, shortly following China’s “Black Monday,” foreign investors pulled a record $19 billion dollars out of Chinese investments. At the end of the week, the outflow totaled $29.5 billion dollars, surpassing any weekly outflow during the U.S recession.
More broadly, the rise and fall of the Chinese Stock Market has stained the market itself permanently. While it has undoubtedly directly affected global equity and commodity prices, it is the indirect effect that will last for years to come. Unlike in other significant economies, institutional investors play a rather small role in China’s stock market. Rather, retail investors, of which more than two thirds didn’t even graduate high school, own around 80% of tradable shares. As a result, China’s market is primarily driven by one force: investors’ confidence. With millions of individuals fleeing the market, even more are destined to follow the pack. This leaves China’s market subject to a downward-spiraling cycle. Retail investors are leaving the market because returns are poor and returns are poor because individuals are leaving the market. Moreover, the increase of capital flight will continue to damage Chinese businesses themselves. While China has already posed stricter capital regulations, and has sought to cut down on money smuggling, the flight continues to grow. As a result, the Chinese government will soon find themselves in a relatively impotent state to defend the market. With few institutional and state-owned investors to command and increasing capital outflows, their artificial stimulation will run out of steam.