So Who’s the Biggest Winner from China’s Stock Market Bubble? Answer: The Government!

I have been pointing out here that the Chinese government has engineered the inflation of a massive stock market bubble as part of “C-O-N-F-I-D-E-N-C-E” building measures, and importantly, as alternative option to secure corporate financing

The Chinese government seems to be hoping that the stock market boom may provide the economy an alternative of finance. They must be hoping that equity may replace credit as a source of financing for credit trouble firms, thus the stock market frantic pump matched by an avalanche of IPOs.

In addition, rising stocks could have been seen by the Chinese government as having the “wealth effect” enough to ameliorate the downturn in the property sector, spur consumer spending and create the impression that the Chinese economy has been recovering.

Little have they learned from their recent experience that the same credit bubble on the property sector has only incited for a huge imbalances. Huge imbalances that has to be paid for, which has been the reason for the recent downturn in the economy.

Well, the Wall Street Journal reveals that the Chinese government has indeed been the major beneficiary from their own bubble blowing policies.  (bold mine)

China’s stock market has risen by nearly a third this year, one of the best performances in the world. But the largest beneficiaries of this spectacular rally aren’t the investors who wagered on the country’s corporations or the companies on the Shanghai exchange.

The biggest winner has been the Chinese government, which has made billions in paper profits on its stakes in hundreds of listed state-owned corporations. Now Beijing hopes the stock gains will ripple through the economy, helping the authorities to improve the financial health of debt-laden state companies.

The challenge for Beijing is how to carefully manage the market’s momentum, given that Chinese stocks are no longer cheap. The Shanghai Stock Market, trading at a price/earnings ratio of around 19 times, is at its most expensive in five years. ChiNext, the board for startup companies on the smaller Shenzhen Stock Exchange, now boasts a triple-digit P/E ratio, roughly five times that of the Nasdaq Composite Index.

So far, Beijing has repeatedly cheered on the rally, to the delight of the small investors who dominate trading. That has helped more than double the market value of the almost 1,000 listed firms—in which the central and local governments own stakes—to 20.19 trillion yuan ($3.26 trillion) over the past year.

So how should the inflation of a gigantic stock market bubble “improve the financial health of debt-laden state companies”????

Analysts said one of Beijing’s biggest hopes is that the booming share market will help companies deal with the vast pile of debt on their balance sheets. Higher stock prices can ease a company’s debt burden by increasing the relative value of a firm’s assets and, in the case of companies that subsequently sell shares, by giving the company funds to pay down debt.

As of now, state-owned enterprises, or SOEs, are among the biggest debtors; their liabilities have risen to 65% of their total assets, from 58% in 2007, when the stock market peaked, according to CEIC, a data provider…

As their stocks have risen, a few state-run companies have taken advantage of their increased valuations by selling stakes or issuing new shares, using the cash to pay down their substantial borrowings.

As companies pay down their debt and raise capital, they are more easily able to go ahead with the mergers and acquisitions that Beijing hopes will make them more competitive. The government is seeking to restructure the country’s sprawling array of more than 100,000 state-owned enterprises.

Accounting magic, that's how. Blowing stock market bubbles reduce accounting debt ratios through inflated asset valuations of state owned firms

Of course, that's aside from increased access to equity financing as alternative to debt. And C-O-N-F-I-D-E-N-C-E.

Essentially by inflating a bubble—via policy easing (or force feeding credit into a credit strained system) and from IPO manipulation—the government transfers resources and risks to the public in order to save the skin of these political enterprises.

But there is no free lunch. Not even for bubbles.

The major cost of inflating a bubble extrapolates to more amassment of debt.

According to a Bloomberg report which covered today’s 3.1% surge in Chinese stocks. (bold mine)

Margin traders increased holdings of shares purchased with borrowed money for a sixth day on Monday, with the outstanding balance of margin debt in Shanghai climbing to an all-time high of 1.28 trillion yuan.

Mutual funds managed a record 6.2 trillion yuan in assets at the end of April, the Securities Times reported Tuesday, citing data from the Asset Management Association of China.

And China’s margin debt, according a study from Macquarie “could already be the highest level of margins vs free float in market history…” (FT Alphaville). Wow!

The above only exhibits more signs of how the Chinese government have been a state of panic. They have been desperately working to survive a political economy deeply dependent on PONZI financing.  So they have been doing everything to cut down the cost of servicing debt (so as to extend the DEBT IN-DEBT OUT operations, where lately they have introduced debt for bond swap), as well as, has increasingly relied on asset sales (previously property and now stocks) for financing.

Yet  when the both bubble bursts the government and the citizenry will be a lot poorer. 

Thanks to the misplaced belief on policies that turns stones into bread.  

As American journalist aptly described of the 1929 stock market crash (The Bubble that Broke the World p.38) [bold mine]

Then the invisible pyramids—what are they? 

A delirious stock-exchange speculation such as the one that went crash in 1929 is a pyramid of that character. Its stones are avarice, mass-delusion and mania; its tokens are bits of printed paper representing fragments and fictions of title to things both real and unreal, including title to profits that have not yet been earned and never will be. All imponderable. An ephemeral, whirling, upside-down pyramid, doomed in its own velocity. Yet it devours credit in an uncontrollable manner, more and more to the very end; credit feeds its velocity 

How relevant this has been today! (not only for China)