The roots of the stock market crisis lie not in the Chinese economy as such, but can be traced to the financial meltdown of 2008. Its impact on China was immediate. With the collapse of world trade in the latter part of 2008 and the early months of 2009, Chinese exports plunged, leading to the loss of 23 million jobs.

Confronting a potentially explosive social crisis, the Chinese regime responded with a $500 billion stimulus package, coupled with a massive expansion of credit to local government authorities to undertake infrastructure projects and real estate development. New urban complexes and, in some cases, virtually entire cities, sprang up almost overnight. Beijing entertained the hope that the world economy was experiencing a cyclical downturn and the previous expansion would resume. The hope ended as a mirage. Today, expanding exports contribute very little to China’s economic growth.

For a time, expanding credit-fuelled infrastructure and real estate development boosted the Chinese economy, sustaining its expansion at, or near, the pre-2008 rates. This prompted the claim by short-sighted economic pundits that China, along with other so-called emerging markets, would provide a new basis for global growth. This prognosis was rapidly exposed, and is now officially acknowledged by the International Monetary Fund and other global economic authorities to have been a chimera.

The Chinese government recognised that the structure of the economy, in which investment, backed by credit, comprised around 50 percent of gross domestic product (GDP), while consumption spending accounted for barely 35 percent, was ultimately unviable.

Consequently, in 2013, the regime initiated a new economic orientation, declaring that henceforth market forces would play an even more “decisive role.” Setting out his agenda in November 2013, at a major meeting of the Communist Party leadership, President Xi Jinping, who had come to power the previous March, declared: “We must deepen economic system reform by centering on the decisive role of the market in allocating resources…”

The new orientation consisted of two key components: lessening state intervention and controlling the financial system, which would increasingly be opened up to international capital flows; and lifting the level of consumption spending in the domestic Chinese economy.

SHORT SIGHTED PRESCRIPTION

An obvious way to boost domestic spending would be to increase the wages of the multi-million Chinese working class. Any significant rise in workers’ wages would mean that Chinese manufacturing firms, which operate on low profit margins as they carry out contracts for major US- and European-based transnational corporations, would be priced out of the markets by cheaper investment sites in Southeast Asia, such as Vietnam. More over there is stiff competition from the United States, which has, itself, become a cheap labour site.

For this reason, the regime, which rules in the interests of the oligarchs who dominate the upper echelons of the Chinese Communist Party, sought to boost consumption spending by another route. It set out to create a “wealth effect,” by encouraging privileged sections of the middle class to invest in the stock market. It lured small investors into the market with the implicit guarantee that the Chinese government, its hands firmly in control of the levers of the financial system, would secure their investments.

The result was a flood of money into the stock market, lifting the Shanghai index by more than 150 percent in the year before it reached its peak on June 12. Much of this investment was provided through margin loans, in which the shares purchased by investors provide the collateral for the loans they receive, with the proviso that a portion of the debt will have to be repaid if the shares lose a certain amount of value.

These loans boost the market during an upswing but exacerbate any fall, with investors confronted by margin calls having to sell some of their shares to meet their debts, thereby creating a downward spiral. This form of debt increased five-fold in the year to June, comprising, at one point, 17 percent of market capitalization

Last April, with margin loans roaring ahead, the government poured more petrol on the flames, allowing individual investors to open as many as 20 stock trading accounts.

The result was a further spurt in share values. Confronting a massive financial bubble, the government initiated a crackdown on margin lending on June 13, setting in motion the present sell-off. The decision to rein in margin lending was premised on the assumption that, with its wide-ranging powers, the government could control the situation and gradually let air out of the bubble.

RUNAWAY PLUNGE

But the laws of the capitalist market have proven to be stronger than even the most powerful regime. The Chinese government now confronts a runaway plunge, threatening to destabilise the entire debt-ridden financial system. Local government authorities alone are estimated to have some $4 trillion in outstanding loans.

The meltdown has potentially explosive political consequences. Having lost all claim to stand for social equality, let alone represent socialism, the “red capitalists” of the Chinese Communist Party (CCP) live in mortal fear of an eruption of social and political struggles by the   working class.

Now, that prospect looms ever larger, as the GDP growth may fall below the official target of 7 percent, and possibly to as low as 4 percent. The financial crisis in China will lead to a further slowdown in global economic growth.

– by Poreg Desk (adopted from WSWS)