The Price of Stocks in China

Perhaps you have heard, and maybe you haven’t, that the Chinese stock market is in a free fall. If your first reaction is, “why does a communist country have a stock market?,” then I’ll give you a moment to come to your senses and join the 21st century, where China is now only “Communist in name only.”

And yet, despite this fall in the stock market, many of us haven’t heard about it here. And, frankly, it doesn’t really appear to be affecting us much either; thus, discussing the price of stocks in China have no more relevance to us than the price of tea in China. But, there are some interesting parallels to China’s situation, which follows some of our own history.

A notable similarity is the stock market in China now and our stock market in the roaring 20s. Private individuals and households are the main investors in the Chinese stock market. This is unlike the United States today, where most investors are large actors like pension funds, mutual funds, or generally what we refer to as institutional investors. This wasn’t always the case in the United States. In the 1920s, more individuals took it upon themselves to invest in the stock market, and many small banks were also taking peoples’ deposits and also, investing as individuals in the stock market. The issue that comes to bear with individual investors is they tend to invest for much more speculative reasons; whereas, institutional investors tend to invest more for the long haul. Thus, when millions upon millions of people act speculatively, the market will experience dramatic swings up and down.

Many interesting laws came about as a result of the Great Depression and many people losing their pants, when the stock market rally in the 1920s tanked. For example, now if you want to sell your stock to the general public, you must be regulated by the US Securities and Exchange Commission (SEC). The SEC requires a high standard of financial reporting, so companies must have great transparency to the public. And, if the company is not publicly traded, then the stock can only be marketed to “accredited investors.” The SEC considers accredited investors to be individuals who make more than $200,000 a year, or $300,000 with joint income from a spouse; or someone who individually or jointly has $1 million in net worth. It is not clear if China has any of these restrictions, which could be further fuel for a stock market bubble.

Of course, understanding the crash of the Chinese stock market isn’t a matter of using hard economic analysis to dissect what is really happening. In a matter of one year, the market has gone from a 52 week low of 2,135 points to 5,178 points. The market more recently closed at 3,726 points. It seems like a simple case of the market overheating due to speculation. Observers believe that the Chinese stopped investing in real estate and piled into the stock market suddenly. And now the market needs to find a new normal, which is probably around the 2,000 level, which is where the Shanghai Composite has floated for most of the past 10 years.

While the price of stocks in China may not affect much our daily business here, it is interesting to see if China may come to struggle with some of the reforms our own country had to deal with. And more interestingly, it is fascinating that the group calling themselves the Communist Party are struggling to deal with free market forces they have created!