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Shanghai’s Liquidity-Fueled Roller Coaster

August 12, 2009

I’m not a market watcher, but lately the sharp daily swings in Shanghai’s stock index have caught my attention.  The moves and the reasons behind them are worrying indications that China’s flood of bank lending (to offset the effects of the global slowdown) is fueling an asset bubble, and that the country’s rosy economic statistics may not be quite what they seem.

On Wednesday, July 29, the Shanghai Composite Index plummeted 5% in a single day of trading.  The sell-off was triggered by a report in Caijing magazine that China’s central bank would require banks to set aside larger reserves, and hence curb their lending.

The next day, after further losses, China’s central bank issued an official statement reaffirming its support of a “moderately loose” monetary policy, which implied that lending would continue apace.  The market immediately responded by rallying 3%, ending up 1.7% on the day.  Over the next several days, the index recovered all its July 29 losses.

Today (Wednesday, August 12), data indicating a slowdown in bank lending again sent the Shanghai index down 4.7% in a single session.  But, lo and behold, Bloomberg has just filed a report overnight saying economists expect weakening exports will cause the central bank to delay tightening.  How much do you want to bet we see a rally tomorrow (and the day after) in response to this news?

This series of events is virtually a textbook example of a liquidity-driven market.  Wednesday rumors of credit tightening?  Sell!  Thursday assurances that easy credit will continue?  Buy!  (Rinse and repeat.)  Market participants act this way because they know that the money that has fueled the market’s 90% rise so far this year (in almost defiant contrast to China’s actual sluggish economic performance so far this year) is supplied by the very lending that might or might not be shut off. 

Since the lending binge began, persistent stories have circulated that a sizeable chunk of the RMB 7.8 trillion in loans issued (in the first half of the year) have actually been diverted to speculation in stocks and real estate.  The market’s hyper-sensitivity to news of continued lending suggests that many investors believe this to be true.  Either that, or they believe the performance of listed Chinese companies hinges almost entirely on an unprecedented (and unsustainable) flow of easy state-supplied credit, which is just as unnerving.

In either case, the dizzying rise in the Shanghai market is looking more and more like a function of runaway asset inflation based on shaky credit, rather than sustainable asset appreciation based the prospect of real growth.

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