As we start to plot the after-effects of the bursting of the China sharemarket bubble, two issues have become dominant.
The first is whether the crash will make it more difficult for China to shift its growth engine from one that rests on building infrastructure and exporting to a more consumer-led model.
And the second is assessing what damage has already been inflicted on the Chinese banking system and may still be inflicted in the future.
Against this background, the KGB yesterday had a fascinating discussion with the ANZ Asian analyst Martin Whetton (which will be published on Business Spectator later this morning).
Whetton underlines that the Chinese had hoped that the strong sharemarket would be of great assistance in helping to boost consumer demand and in smoothing the transition to a consumer society.
The question now is whether this sharp fall in the sharemarket means that, instead of aiding the transformation, it will hold back consumer demand.
Certainly, in my experience of western societies, big sharemarket falls dampen consumer expenditure, particularly if they spill over to the property sector.
If Chinese consumer demand follows that pattern and becomes depressed, then China’s growth rate will fall below current expectations.
In this context Whetton even raises the possibility that demand for iron ore could actually fall, thereby reducing volumes at a time of higher production. If that happened, the iron ore price would fall even further and other commodities would come under further pressure.
Australia has a big stake in the China consumer outcome. If China’s growth declines, we will decline even further and the current ‘income recession’ will become something more serious for the whole economy.
The Federal Government’s taxation revenue will be much lower than is currently anticipated.
In time, any China consumer problem can be solved but if there is a deep banking system problem then the decline will be drawn out and there is danger of a repeat of the Japanese experience (China must heed the lessons of Japan, July 9).
The fact that the Chinese have suspended half the stocks on the Shanghai and Shenzhen exchanges shows that they are clearly concerned that their banking system is being put under pressure.
Whetton points out that when you suspend half your list, those seeking cash must sell the better stocks, which remain listed. This puts increased pressure on those shares but it also opens up the beginnings of a solution which allows them to curb the flow-on effects to the banking system. This is really tough on the investors, but it makes it easier to repair the banking system.
We have seen in Europe how the authorities were able to buy bank paper, including Greek paper, so that the stability of the banking system was no longer jeopardised by events in Greece, Italy, Spain and other weaker countries. This greatly added to Europe’s stability.
The Chinese would have watched this process with considerable interest.
They can now support the sharemarket to enable those who are over-borrowed to sell better stocks and repay the banks and other lenders and so reduce the vulnerability of the banking system. That’s exactly what happened yesterday in the Shanghai market.
Once again we saw the normal early sellout of those who were subject to margin calls, so the China market opened lower. But then, particularly after the lunch break, there was strong buying and it is highly likely that the buying was government-driven, perhaps by issuing instructions to Chinese institutions to support the market and help get the banking system off the hook.
And, of course, with so many stocks suspended and all IPOs cancelled, the government-inspired buying could be concentrated both on a lesser number of stocks and better quality stocks.
When, finally, the suspended stocks regain listing they will decline sharply. No one knows the China plan but my guess is that they will not allow re-listing until the banking system can handle it.
In terms of Australia and Asia, what happens in China in the next six months will play an enormous role in regional fortunes.
But one good news anecdote, Whetton does not believe the pricking of the sharemarket bubble in China will affect Chinese buying of Australian apartments and dwellings.