STAFF NEWS & ANALYSIS
'I Trusted the Government Too Much'
By Joe Jarvis - August 07, 2015

Investors throughout China are waiting for the government to step in and buy more stocks so they can close out their positions, but many are losing hope.

Yang Cheng, a farmer in the remote town of Panzhihua in southwest China, was one of many Chinese citizens who started buying up stocks after the government began promoting equity investment as part of a larger plan to expand the country's economy.

"When the market climbed to 4,000 points, I realized the risks were pretty high. However, public opinion on government policies affected my judgment," he told CNBC.

But after sinking his entire life savings—$164,000—and his relatives' money into shares of a local mining company, he lost everything. Not only that, but Yang's brokerage convinced him to borrow more than $1 million to buy stocks on margin. He now owes roughly what he originally invested after liquidating his portfolio.

Like many Chinese, Yang traveled to the office of the leadership and stock market regulator in Beijing to seek help, but was turned away.

"I don't know what to do. I trusted the government too much. I won't touch stocks again," Yang said. – CNBC, July 28, 2015

When farmers plunge their life savings into mining stocks at 6-to-1 leverage, it is fair to assume a bubble has formed that will eventually pop. That is certainly the case in China right now. Farmers like Yang Cheng made the mistake of believing their government. We suspect he won't make that mistake again.

Financial markets help a country's economy by, among other things, providing price discovery. The share prices established by buyers and sellers give everyone else important information on the value of listed companies. Yet the information loses its value when non-rational investors intervene.

In China's case, Beijing tried to boost economic growth with fiscal and monetary stimulus. Chinese businesses, seeing a drop in demand, declined to use the resulting liquidity to increase their production capacity. The stimulus money had to go somewhere. The country's capital controls meant it could not go outside China. The stock market was one of the few available investments, so shares prices quite naturally rose far more than was otherwise justified.

Farmer Yang and his peers no doubt thought they were being smart and patriotic to buy stocks. Having lived their whole lives in a communist society, the government had always taken care of them. Not this time.

While the loss must be painful, Yang seems to have learned a valuable lesson. "I trusted the government too much," he said. He will likely give future government promises a more skeptical hearing. This is good, because government rarely delivers on its promises.

This isn't a uniquely Chinese situation. Politicians around the globe make promises they can't keep all the time. Citizens around the globe believe them. The lucky ones learn their lesson early on and don't have to endure such huge losses.

If China is ever to have an even remotely "free market" economy, it has to stop intervening and let markets operate freely. If they had done so, it would not now be collapsing because it would not have gone so irrationally high in the first place.

Beijing apparently thinks it can maintain its tight grip on power and still enjoy the benefits of capitalism. They've done it surprisingly well so far, but eventually they will have to make a choice. Farmers like Mr. Yang won't be burned twice.

Posted in STAFF NEWS & ANALYSIS
loading