The current stock market mania in China's mainland has as much in common with the Tulipmania of the 17th century, as it does with the Internet boom of the late 1990s. In particular, the run-up of the Shanghai index is remarkably similar to the recent meteoric rise and collapse of the Arab markets -- down 70% since February 2006. Both took root in a country that had little or no experience with a stock market. And, a "this time it's different" atmosphere pervaded, a set of new fangled heroes drew in millions of unsuspecting small investors, and those who came late to the party ended up suffering devastating losses after the inevitable crash. Like the Arab markets, the Shanghai market is closed to foreign investors. But as the 9% drop in the Shanghai index on Feb. 27 shows, unlike the collapse in the Middle East, the impact of the Shanghai swoon can be felt all the way to Wall Street.
Even the biggest China Bulls around admit that China is in a bubble. The Shanghai Composite Index is now approaching 4,000 -- a rise of nearly 40% so far this year after a 130% increase in 2006. The Shanghai and Shenzhen exchanges now have a market cap of about 15 trillion yuan ($1.8 trillion). While that doesn't make it a big market globally -- the New York Stock Exchange had a total capitalization of $26.5 trillion as of Dec. 31 -- China's market places second in Asia, behind Japan, after surpassing Hong Kong just last month.
China's Stock Mania: "Like a casino set up by the Communist Party"
Anecdotal accounts of China's current mania are distressingly familiar. Investors are queuing to open accounts at local securities houses, as applications are five times as high as a year ago. Students and pensioners crowd around computer terminals watching ticker signs go by. A self-appointed "stock god" like Lin Yuan lectures hundreds at Peking University to reveal his secrets on how he has made some 400 million yuan ($52 million) in the market. One out of three university students in China is playing the markets.
New technology -- Internet and mobile telephony -- has only exacerbated the mania. Broadband penetration means that housewives, pensioners and students all are on the same playing field. Many employees spend their workday trading through e-mails and instant messaging. Companies have introduced fines to deter employees from spending their time trading stocks online. It has all been in vain. Mobile-telephone users trade shares simply by pressing buttons on their handsets.
There are now more than 91 million accounts held by individuals at brokerages or in mutual funds. About 10% of these accounts were opened in just the first three months of this year -- and 10 times as many accounts were opened in first quarter 2006 as for all of 2005. Online trading is spreading rapidly, and in recent weeks individuals have been opening stock-trading accounts at the rate of about 90,000 per day -- 35 times the pace of a year earlier.
Since China doesn't permit brokers to offer margin trading, China's stock market newbies have started pawning personal assets to invest in shares. Some are pledging their homes as collateral for personal loans. Beijing residents last year pawned houses valued at 1.5 billion yuan ($195 million), much of it in order to buy shares. Pawnshops in Shanghai confirmed that their business was now dominated by loans against apartments to fund stock buys. Like the merchants who sold picks and shovels to prospectors in the California Gold Rush, it sure is good business. The pawnshops charge a monthly interest rate of 2.5-3% for loans backed by apartments. One pawnshop even has taken out advertising space on taxi windows.
China's Stock Mania: What is To Be Done?
Few of today's speculators recall that this is China's second stock market mania. In the first three years after stock trading began in China during 1990, the Shanghai index jumped six-fold. Trading got so heated that riots broke out among people hoping to get in on initial public offerings. The stock market became a playground for manipulation and scandal throughout the 1990s. The market drifted into virtual irrelevance, before it came back to life at the end of 2005.
Today, the Shanghai market may have already peaked. The bottom has already dropped out of the markets twice this year -- on Feb. 27 and April 19 -- on the back of rumors of a government crackdown. China's leaders are worried, but essentially helpless. Local players have ignored interest-rate rises and increases in banks' reserve requirements. And there's little the government can do to control the Chinese obsession with gambling. It's no surprise that the same year that Shanghai more than doubled, the casinos in Macao recorded higher revenues than the Las Vegas Strip.
Here's my prediction. The China stock mania will end in tears -- as has every other stock market mania in history. Indeed, place the long-term charts of the Shanghai index alongside the NASDAQ, and the patterns are eerily similar. The Chinese authorities will try to intervene -- unsuccessfully. And when the bubble pops, the negative effects will be profound. Students and pensioners stayed on the sidelines last time around. This time, they will be the most affected. If tens of millions of urban Chinese lose their shirts, they'll be looking to the government to bail them out -- or else, they will turn very angry. Not even Chinese mandarins have power over the laws of financial speculation.