Desperate Measures and The Madness of Crowds

The Shanghai Composite Index - the Chinese Stock Market - has plunged about 30% in three weeks. About half of the companies listed on the index asked for halt trading orders on July 8 to try to stop the bleeding.

The Government has ordered Government-owned enterprises to stop selling shares.  It has also is ordered CEOs and other officials in major Chinese companies who have sold in the last six months to buy their shares back, and they will be forbidden from selling again at least for the foreseeable future.  If the shares in their companies fall another 30% in the next 10 days, they will be required to buy more shares.  The People's Bank of China has indicated that it will provide support to the China Finance Securities Corporation which provides margin debt - the debt that investors use to invest beyond their means.  In essence, the Chinese Central Bank will flood the Chinese Margin Bank with new cash to entice investors to take even greater risks in the market.  Chinese insurance companies will also be encouraged to buy into the market as they will be allowed to hold 40% of their assets in equities, up from 30% previously.  Finally, a group of 21 state-owned brokerage firms have mobilized about $20 Billion to plunge into Chinese blue chip (a.k.a. major state-owned) companies to play their part supporting the market.

If this all sounds utterly bizarre to you, it should.  No market operates like this, and no government has ever ordered individuals to buy stocks to buttress a market.  Is there a gulag waiting for these people if they refuse to invest?  Central banks are also not supposed to buy equities.  Funnelling new cash to a margin bank is essentially the same thing, making a mockery of the People's Bank of China's claim to be a legitimate player in the small club that includes the world's central banks that actually matter (i.e. the US Fed, and the ECB).

The Shanghai Composite Index was up about 150% in one year prior to this "correction".  About 80% of investors are individuals, many of who were investing for the first time.  These people have moved with lightening speed from "Greed and Complacency" to "Fear and Extreme Discontent", which is the hallmark of The Madness of Crowds phenomena that occurs when asset bubbles burst.  Pay attention - this may be exactly what it will look like when bubbles in the equities markets in the West start to burst as well; small investors stampeding for the exit, while governments and central banks desperately try to stop the rush in its tracks.