Stock market crash 101, China's lesson in capitalism: Patrick Brown

Trying to follow the recent contortions in China's stock market is a bit like watching Mickey Mouse in the Disney film Fantasia desperately attempting to stop the pandemonium he's caused by using the sorcerer's magic hat.

Communist Party leaders scrambling to tame stock markets gone rogue are dealing with forces they clearly do not quite understand.

• China's stock crisis doesn't compare to Greece's
• Asian markets plunge despite Beijing's interventions

Last year, China's stock markets suddenly woke up after a long stagnation, and word of easy money spread quickly.

Tens of millions of small investors joined the trading craze, pushing stock prices up roughly 150 per cent in a year.

Ignoring the sober reminders of what happened when the Dutch went mad over tulips in the 1630s, the British over the mysterious South Sea Company in the 1720s, and the whole world over dot.coms in the 1990s, party officials chortled over China's stock miracle, and claimed credit for it.

On June 12, the chairman of the Securities Regulatory Commission, Xiao Gang, told a meeting of top leaders that the bull market still had room to climb, while the Peoples' Daily said that rising stock prices are part of the "China dream" — President Xi Jinping's slogan to restore the country to its former glory.

The next morning, the inevitable crash began.

As the market's value dropped by a third, the government jumped in with both very large feet.

Brokerage firms were ordered to buy up stocks to the tune of almost $20 billion of their own money, alongside $40 billion from the government.

Major shareholders, directors and managers of big companies were ordered not to sell shares for six months, and insider trading rules were relaxed to encourage them to buy stocks.

Meanwhile, half of the country's listed companies were allowed to stop trading to freeze their stock prices, while small investors, having been earlier warned of the dangers of borrowing money to buy shares, were now being encouraged to do so and even to use their homes as collateral.

To try to prop up the plunging markets, the yuan was devalued, interest rates were cut, and tens of billions of stimulus dollars were pumped into the economy.

'Decisive role'

These extraordinary emergency measures, which would be almost unthinkable for a Western economy facing a similar crisis, essentially undo a commitment made by President Xi at the beginning of his term to allow market forces to play "a decisive role" in China's economy.

Now, as far as stocks are concerned, the Communist Party looks to have done everything it can to put the genie of market forces back in the bottle, short of buying up everything and turning the clock back to state ownership.

The very large numbers involved in any story about the Chinese economy have led to fears that the trading giant we all rely on is about to collapse.

But this would be a mistake, as is all the news coverage with pictures from Chinese stock markets of people staring at screens glowing bright red, apparently lamenting their losses.

Red being traditionally associated with good fortune, Chinese stock tickers use it for gains, green for losses. (Even Fortune Magazine, the American business bible, got this backwards by reporting a rally with a photo of green screens and the cutline "Back in the green again.")

It is easy to misunderstand if you're missing some basic knowledge.

And so it is with the large numbers in this crisis, if you don't pay attention to the even larger ones that show a bigger picture.

Test of leadership

About 90 million people trade stocks in China, many of them doing so for the first time in the past year.

It's a lot, to be sure, but it's only about seven per cent of the population.

Similarly, according to the Economist, the amount of money wrapped up in traded stocks is only about 30 per cent of China's GDP (compared with 100 per cent or more in Western countries), and the amount of money borrowed to buy stocks is only about 1.5 per cent of the assets in its banking system.

What's more, if markets are down 30 per cent on the month, they are still up almost 80 per cent on the year.

The international impact is also relatively modest. Despite globalization and the critical importance of trade with China to many countries, including Canada, there is something of a firewall between Chinese stock markets and the rest of the world.

The reality is that the greatest immediate damage done by China's year of living dangerously in the market is not to its or the world's economy, but to the credibility of China's leadership.

Command and control

The dramatic and disproportionate rescue effort these past days reflects Beijing's fear of public opinion should economic bungling lead to millions losing their life savings.

The potential international risk from the crash is a long-term one, depending on whether China's leaders, having now had their fingers burned, lose their appetite for more economic reform.

A significant slowdown on that front would affect the whole world.

The transition from the poverty and squalor of a Marxist-Leninist economy to a prosperous market one is still a work in progress, and it probably cannot work effectively if the party insists on slamming on the brakes every time there's a bump in the road.

While highly sophisticated, experienced and knowledgeable people are to be found at all levels of the Chinese economy, public and private, many at the top still instinctively cling to the old ways of command and control when things get tricky.

China's stock market crisis is far from over, and the fallout from it may well reach beyond the small, newly middle-class investors whose shirts are on the line.

As far as the world is concerned, though, it is probably fair to say that, so far at least, market-ignorant Chinese Communist officials have done far less damage than clever American bankers did in 2008.