With the Real Estate Crash and Debt Defaults China Will Have to Withdraw From Almost All Global Financial Funding Channels

With the Real Estate Crash and Debt Defaults China Will Have to Withdraw From Almost All Global Financial Funding Channels
The People's Bank of China, the central bank of China, in Beijing, in a file photo. maoyunping/Shutterstock
Law Ka-chung
Updated:
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Commentary

Last week, the Chinese stock market plummeted; the Shanghai Composite Index (SHCOMP) dropped below 3,000 points, a mark of psychological significance. This happened against the backdrop of a “market rescue” by the authorities, which had banned short-selling positions by senior management of listed firms. As expected, such an act illustrated a classic example of bad signaling, conveying a negative insider message to the market.

The government being slapped hard by the market also suggested a substantial extent of policy ineffectiveness.

The Chinese government had disregarded the gloomy stock market for over a decade. Ever since the financial tsunami, SHCOMP had been trading around 3,000 points for 15 years except for a short while in 2015, a level roughly half of its best time (6,100 points) in 2007.

The sudden forceful rescue attempt reveals another piece of important information: that the real estate bubble burst and the accompanying debt crises have reached a critical moment. Even a tiny additional outflow from the already dead stock market would be fatal.

Another backdrop is the massive fire sale of A shares and Foreign Direct Investment (FDI) outflow seen recently. Such outflow is comprehensive enough that whether it is short-term capital from the stock market or long-term investment, they are fleeing.

The moment is critical in two ways: One is the recent surge of global interest rates driven by the U.S. long-tenor sovereign yield. This re-evaluates every investment where often the most fragile markets (this time China) would be out of cash first. Another is the worry of a new war in which China is one potential candidate.

(KC Law, Ka Chung)
KC Law, Ka Chung

From our standard comparison of China with Japan, the SHCOMP index is projected to have a deep slump in this round. A logarithmic scale suggests the low of this round could be down to 1,500 points, or another 50 percent deep discount from its current level.

Fundamentally speaking, most listed firms are more or less dragged down by the real estate sector. Deleveraging is not done in a day, the weak stock market will take time to recover. However, this might not be a big deal because most retail investors have already given up.

But such development has a strong implication: While the series of debt defaults has certified the death of the Chinese debt market, the death of the stock market will also be certified soon. This means China will have to almost completely withdraw from all global financial funding channels. Can you imagine a huge economy that goes without finance nowadays? By definition, this means a deepening of deleveraging.

More importantly, this further means future re-leveraging will be very prolonged, difficult if not impossible.

Coincidentally, the global stock markets are coming down from their very respective tops. This somehow foresees a global recession is very near if not yet started. The upcoming bear market will be very challenging to China, not only confined to the market but also to its macro financing. And such turmoil can become a social or even political one.

KC Law, Ka Chung

Law Ka-chung
Law Ka-chung
Author
Law Ka-chung is a commentator on global macroeconomics and markets. He has been writing numerous newspaper and magazine columns and talking about markets on various TV, radio, and online channels in Hong Kong since 2005. He covers all types of economics and finance topics in the United States, Europe, and Asia, ranging from macroeconomic theories to market outlook for equities, currencies, rates, yields, and commodities. He has been the chief economist and strategist at a Hong Kong branch of the fifth-largest Chinese bank for more than 12 years. He has a Ph.D. in Economics, MSc in Mathematics, and MSc in Astrophysics.
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