The Shanghai Stock Exchange fell 8.5% last Monday, then rebounded later in the week. Despite this, the Chinese authorities are supporting the market, which in turn has caused much free market tut-tutting from Western analysts.
But given the fragile nature of the Shanghai market and the inexperience of Chinese retail investors, the authorities can't afford to take a purist free market approach. Still, there may be a policy solution to their problem.
You see, the run-up in Chinese stocks to its peak in June 2015 had been ebullient.
A Washington Post story on the Shanghai market had some fun examples of excess. Like how a Chinese real estate company had changed its name to P2P Financial Services Co. without bothering to develop a peer-to-peer lending business, yet saw its stock jump 10%.
The Post's story also pointed out that Chinese stock markets rose enough during the year to create $6.5 trillion of value! That's about 70% of China's 2013 GDP and 40% of the New York Stock Exchange's value.
But, long term, the Shanghai market doesn't look overvalued.
Seeing What's Actually There
The market is now a third below its all-time high, reached in 2007. It's 5.5 times the level it was 20 years ago, at the beginning of August 1995. That sounds like a lot, until you remember that the Chinese GDP in 2014 was 10.2 times the level it was in 1995 in renminbi terms, or 14.5 times its 1995 level in dollar terms.
Thus, since 1995, the Chinese stock market has risen only half as much as the nominal GDP. For comparison, the U.S. stock market, which is standing at 4.5 times its early 1995 level, has risen more than twice as much as the nominal GDP since 1995.
You also have to remember that Chinese savings are much higher than those in the United States (and that there are four times as many Chinese as Americans). Chinese households save more than 20% of the GDP, about $2 trillion in 2015. By comparison, U.S. household savings, at 5.5% of the GDP, are less than $1 trillion. As Chinese savers have reoriented from housing to the stock market, it's not surprising they've caused a boom.
