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The Shanghai Composite Index is up 12.8% from the depths it plumbed on 8 July and round one of the epic battle between the Chinese government and the evil sellers of stocks seems to have gone in favour of the authorities. With a clampdown on stock selling, loans by the central bank to buy stocks and with an enormous $483 billion worth of firepower lined up to support share prices, the Xi Jinping put appears firmly in place. As for the rest of the world’s stock markets, they barely blinked, in spite of the Chinese meltdown being reinforced by a re-run of the Greek circus.

Experts seem to believe the Chinese casino is not of much importance to its economy. A Citibank research report dated 17 July said, “While the distributional effects may be meaningful for segments of the urban middle class, it is unlikely that the effects will be very large on aggregate consumption." In other words, while the suckers who entered late, seduced by the government’s encouragement of the runaway rally, may be burned, the wealth effect is not very large in China and it’s unlikely to have a significant impact on overall consumption demand in the economy. A Barclays report on 17 July said, “China’s equity market is not yet a major source of corporate financing, accounting for less than 5% of total social financing, compared with more than 10% from the bond market and 75% from bank lending." Morgan Stanley said the issues relating to margin financing are unlikely to trigger systemic risk, the effect on the Chinese economy will be limited and even if spillover risks materialize, policymakers will respond adequately. Faith in the Communist Party appears to be widespread in the stock markets.

Sure, they do point to a few things that may be affected. For instance, it’s possible the Chinese authorities want a shift away from savers putting their money in real estate and wanted the stock market to emerge as an alternative. Faced with a slowing economy, they may have sought to stoke a wealth effect. They might have thought a booming stock market would be the antidote to the very high levels of corporate debt, allowing companies to raise equity and repay their debt. These efforts may not now bear fruit. Or they may have merely looked to the West and its allies with their quantitative easing programmes and thought that if Yellen, Draghi, Abe et al could try and boost their economies via the wealth effect through higher asset prices, the Chinese could do it much better. It’s another matter, of course, that history is littered with examples where such propping-up operations have had completely unintended consequences.

The problem with the comforting notion that the Chinese stock market doesn’t matter much is a simple one: if it really didn’t matter, why on earth is the government panicking? Why is it expending so much firepower if it knows the stock meltdown will affect only a few speculators? If the economy isn’t going to be affected much, if there’s unlikely to be contagion from margin debt, why go all out to support the market? Why, if there’s unlikely to be social unrest, is the government so worried? The Citibank report has an answer. It points out that the Chinese authorities are extraordinarily averse to volatility, be it in equities, foreign exchange, growth or employment. Aversion to volatility is a polite way of saying the government wants full control. It wants to be in control of the markets, of the exchange rate, of the rate of economic growth, of the Internet, of politics, of its people’s lives, of what its people think. That is one reason why gaining control over the market meltdown is so important.

And that is where we come to the principal contradiction in China today. Mao Zedong used to say the history of a society is a history of its internal contradictions. He was fond of contradictions and even wrote a book on them, with the rather neat title of On Contradiction. He made a distinction between what he called the principal contradiction and other, lesser ones. If he were alive today, he would doubtless say the principal contradiction in China today is between the rule of the Communist dictatorship and the increasing reliance on the markets.

Now consider that, as Credit Suisse put it in a recent note, “China is in the midst of a triple bubble, with the third biggest credit bubble of all time, the largest investment bubble (proxied by the investment share of GDP) and the second biggest real estate bubble" and it may therefore be apt to compare it with something else that Mao wrote on the subject of contradictions. He said, “Before it explodes, a bomb is a single entity in which opposites co-exist in given conditions. The explosion takes place when a new condition, ignition, is present." The Chinese Communist Party, no doubt learned in Maoist lore, knows this well, which is why they are so worried.

Manas Chakravarty looks at trends and issues in the financial markets. Your comments are
welcome at
capitalaccount@livemint.com

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