While we’ve all been watching Mr Varoufakis collectively refer to the Eurozone finance ministers as terrorists, China has been losing its mind.

If that sounds boring, and you’d prefer to re-engage with some Greek crisis (I am almost out of words), then head on over to Ezra Klein at Vox. I particularly liked “Greece’s debt crisis explained in charts and maps“. There were a few that I hadn’t seen before – and for more, here is his main page. Also, if you’re interested in the new ELA collateral haircuts that were announced yesterday, depositor bail-ins, and Goldman Sachs’ conspiracy theories thereof, then you can’t go wrong with zerohedge.

But back to China.

This:

So comparing that to the other global exchange indices:

Then let’s expand that over the year to date:

And then compare it to the rest of the world (again):

And finally, for fun, here are the last five years:

So, some observations:

1. China has clearly been in a stock market bubble since somewhere toward the end of last year; and
2. That bubble is now popping.

Fortunately, the rest of the world is mostly locked out of mainland China markets, so we’re getting to watch from the sidelines in slightly anxious bemusement. And get distracted by Greece. Even though China has the second largest stock market in the world outside of the US.

You know you’re in a bubble when…

I’ve written this somewhere before: but a good rule of thumb for realising that a bubble is reaching its climax is when you get told by random friends that you need to invest in something. For example, I starting writing about the collapse of the Bitcoin bubble (back when prices were skyrocketing up to over $1,000) almost entirely because someone that I knew vaguely through the social grapevine “quietly” informed his friendship group that he’d bought some Bitcoins. The thought in my head was: “Well, if you are buying them, summin’ about to pop.”

Look – it obviously depends on the person involved. If you’re talking to a successful stock trader, then best take his advice. But if you’re talking to the kind of person that works 9 to 4 for a small factory that manufactures tarpaulins, and eats breakfast at Wimpy, then you had best believe.

So here is an entertaining extract from the WSJ:

Financial advice from your hairdresser…

Anyway, the most entertaining part of all this has been watching the reaction of the Chinese government.

Because not even stock markets are free in China.

How To Deal With A Non-Free Market Stock Crash

When the stock market is crashing, do these things:

1. Tell some stock-brokerages that they need to start buying shares themselves. Call it a “market-stabilisation” fund.
2. Cut interest rates to make it cheaper for retail investors to borrow money to buy shares.
3. Tell all the retail stock investors that you are going to pay their margin calls so that they can continue to buy shares without money! Well, really: “the Chinese central bank pledged to provide funding to support brokerages’ margin finance operations that allow investors to borrow cash to buy stocks.“
4. Call a halt to any new IPOs. Because investors have enough shares to buy that they’re not buying.

Free-marketeers everywhere are shaking their heads in disapproval. But as the Deputy Dean of Renmin University’s School of Finance* says:
*not sure who that is or where that is, but I like the quote.

They must rescue the market with all their means. The ’what if’ scenario cannot be allowed. The evaporation of fortunes of more than 80 million individual investors would pose unthinkable social problems for the country.

What Seems To Have Happened

1. Chinese retail investors bought stocks on margin, meaning that they put down a deposit of, say, 5% on their total share purchase.
2. Paying a 5% deposit allows one to buy 20 times the amount of shares that one would otherwise have been able to purchase with that 5% deposit*.
   *The math: say I have $100 to invest. If I go directly to the stock market, I can buy $100 worth of shares. But if I rather put that down as a margin deposit, then that $100 could be the 5% deposit, allowing me to buy $2,000 worth of shares.
3. How margin trading works in a sentence: the brokerage can allow your portfolio to fall by 5% before they sell off the shares and keep your margin deposit to cover their losses.
4. What that means:
   1. While the stock market is going up, there’s no worries.
   2. As the stock market falls, the broker will make a “margin call” (basically asking you to put more of a deposit down to cover the potential losses).
   3. If you can’t meet the margin call, the broker will sell your portfolio off.
   4. Selling off stocks during a drop in the stock market is a pretty good way of making sure that the stock market continues to drop.
   5. This results in more margin calls.
   6. Even if you’d paid the first margin call, you might get a bit panicky about throwing more money after a falling stock market.
   7. Cue: more selling of stocks. And more drops in share prices.
   8. More margin calls.
   9. And so on.
5. And for the last few weeks, that spiral has been accelerating.
6. According to Bloomberg, traders cut $15 billion worth of investments purchased with borrowed money yesterday alone.
7. That “market stabilisation fund” that the Chinese authorities announced over the weekend? It was only about $19 billion. Awkward.

But It’s Not All Bad News

Even more curiously, because most of the money in the Shanghai Exchange belongs to small retail investors, this stock bubble pop might even be good for the Chinese economy. Like, not in a long-term “life without bubbles is better” – but more in a “could be good today!” sense.

A quote from another Bloomberg piece:

Soaring equities may be bad for the economy because consumers are encouraged to hold off on spending and put their money into the market instead. A doubling of China’s main indexes in the past year coincided with the weakest economic growth in a quarter century.

Ain’t it crazy?

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.