Post July 4th: An Answer to What's Happening in China's Stock Market

Our last post about China's stock market noted the theory that China's central bank's counter-measures might be slowing if not reversing a dramatic collapse. After a quick drop, the central bank lowered interest rates and lowered required bank reserves - both measures designed to provide the balm of liquidity to a festering stock market. Voices were raised both praising this swift reaction as well as claiming victory. But a one day reversal after a big drop doesn't prove anything. And so we posted:

"After all, a bounce after a severe drop is simply natural market action..."

Sure enough, Friday's action weighed in on our side, vs. the central bank cheerleaders:

Chinese stocks crumbled another 6% Friday, despite the government throwing everything but the kitchen sink at engineering a rebound. In fact, it did throw in some kitchen sinks, telling investors they can now use apartments as collateral on margin loans.

And yet one notes that China's government and central bank, partners in a centrally planned economy which claims to be utilizing the best of capitalism and the best of socialism (really Marxism), have historically been able to resist market forces, reverse economic recession, ameliorate social unrest, seeming to defy the laws of economics and markets known to mankind since time immemorial. Or have they?

Just because China has had success controlling market forces in the past, doesn’t mean it always will.

We remember reading endless claims by a famous investment analyst who has extensive ties in China's business, government and investment circles. Following the 2008 financial crisis, this individual patiently and persistently proclaimed that China's leaders knew exactly what they were doing. They would never allow a serious recession. They would take any measures necessary to avoid the sort of catastrophic market collapse experienced in the developed world. With each slip and tumble, this analyst jumped into the fray and reassured all potential investors to stay the course. China's economy and stock market would continue to defy not only gravity but the natural corrective tonic that economies and markets imbibe after rising for extended periods. No worries. China was on the road to prosperity and nothing could deflect the march upward.

Did Friday's market action finally break the spell? We don't know how this analyst will respond. We wouldn't be shocked if they held fast to their thesis that those who would bet against China simply don't understand. They can't understand because they don't benefit from the insider's view.

So what are we to think now. The bounce did not prove out the theory that the central bank's measures stopped the slump. Friday's six percent drop tells us something's going that may represent a crack in the Chinese government's hypnotic power. And this week appears to be confirming the breaking of the spell.