Bubbles & Bursts Part 9: Chinese Stock Bubble (2015)

2015 stands out as a tumultuous year in China's financial annals. That year, the country's stock market experienced one of its most volatile periods, marked by a sharp ascent in the first half, followed by a swift and dramatic decline. Within just a few months, China's stock market went from being a beacon of prosperity to a cautionary tale about unchecked speculation and government intervention.

The Chinese stock bubble was fueled by government policies and announcements.

Speculative Frenzy

In the lead-up to the bubble, there was unparalleled interest in the Chinese stock market. Various elements stirred this unprecedented rise:

State Media Endorsement: Chinese state media frequently painted a rosy picture of the stock market's potential, encouraging citizens to invest.
Sudden Rise: Starting in the latter half of 2014, the Shanghai Composite Index began a rapid climb, from a base just above 2,000 points. By June 12, 2015, the index had reached an astronomical peak of 5,166 points, representing an incredible 150% gain from the previous year.

The Chinese stock market appreciated by 150% in just a year.

Retail Participation: A unique feature of the Chinese market during this period was its retail-driven nature. A huge number of Chinese citizens opened stock trading accounts. Estimates indicated that at the bubble's peak, over 40 million new stock trading accounts had been created and about 85% of trades in China's stock markets were made by individual retail investors. This intense retail participation made the market vulnerable to herd behavior, resulting in wild price fluctuations.
Margin Financing: Exacerbating the situation was a surge in margin financing, which had risen to record levels. At its zenith, the outstanding balance of borrowed money in the market touched over 2 trillion yuan (around $300 billion), allowing for massive leverage but also amplifying risks.

The amount of borrowed money correlated closely with stock market valuations.

The Peak And Inevitable Collapse

The rapid ascent couldn't be sustained, and by mid-2015, signs of an impending collapse became evident:

Initial Decline: Beginning in June 2015, the market started its descent, with the Shanghai Composite Index dropping over 30% in a month. By July 2015, nearly $3.5 trillion in market value was obliterated, sending shockwaves throughout the global financial system.
Trading Halts: The severity of the situation was evident when over 1,400 stocks, constituting around half of the mainland China-listed market, filed for a trading halt to stem the freefall in their share prices.
Liquidity Crisis: Leveraged investors faced margin calls, further intensifying selling pressures. In a matter of weeks, stocks worth over $4 trillion were wiped off Chinese stock exchanges.
Government Intervention: In an effort to arrest the decline, the Chinese government intervened in several ways, including halting IPOs, introducing a stock market "circuit breaker", and orchestrating state-backed company share purchases. Furthermore, they rolled out a $19.3 billion fund dedicated to purchasing shares of smaller companies and extended a credit line of 30 billion yuan ($4.5 billion) to the nation's margin finance agency.

Aftermath And Legacy

The 2015 bubble left profound scars on China's financial landscape. With the evaporation of trillions of dollars in market value, many retail investors suffered heavy losses. The crash resulted in tightened regulations, with the government imposing stricter rules on margin financing to prevent excessive borrowing. Moreover, the role of the Chinese government in managing market dynamics was deeply scrutinized. Many questioned the efficacy and appropriateness of some of its interventions.

However, lessons were learned. In subsequent years, China's regulatory framework has evolved, prioritizing market stability and risk prevention. This period also reinforced the importance of investor education and the dangers of speculative trading driven by borrowed money. As for the broader global context, the bubble's burst was a stark reminder of the interconnectedness of modern financial markets and the potential ripple effects of a major market's downturn.

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