The Econophysics Blog

This blog is dedicated to exploring the application of quantiative tools from mathematics, physics, and other natural sciences to issues in finance, economics, and the social sciences. The focus of this blog will be on tools, methodology, and logic. This blog will also occasionally delve into philosophical issues surrounding quantitative finance and quantitative social science.

Sunday, April 29, 2007

Makings of a Chinese Stockmarket Bubble?

China is in the midst of a stockmarket frenzy. According to an article in The Economist magazine (April 26, 2007), new accounts at stock brokers are being opened at a rate of more than 200,000 a day (e.g., more than 310,000 on April 24th of this year). Many of these punters are relatively new to the market and are often either unsophisticated or relatively low-income (including, students and old-age pensioners).

What is fueling this madness for stocks? Despite a couple of scares earlier this year (February 27, and April 19), phenomenal returns (for now). E.g., the Shanghai Stock Exchange's composite index rose by about 130% in 2006 (and is still rising). (See the chart below.)

Having seen some newspieces from China Central Television's channel 4 news on the latest stockmarket craze, I can see how much the stockmarket has permeated daily life in China.

It's worth noting that another factor, besides hyperbolic returns, is driving this 'investing' frenzy -- consumer technology. By "consumer technology" I don't mean China's equivalent of tech stocks (although I'm sure they are enjoying a boom). Instead, it is the growing availability of communcation devices like cell phones, instant messaging, and broadband Internet connections that have reinforced and further enabled this stockmarket 'madness of crowds.'

So is this a bubble? It certainly has all of the earmarks of a stockmarket bubble that will eventually burst. The recent past has demonstrated that Chinese stockmarkets (in Shanghai and Shenzhen) are vulnerable to market volatility as well as to macroeconomic shocks and policy changes by the Chinese Communist Party.

One of those Chinese would-be investors, when describing China's stockmarkets, quoted by The Economist summed it up best: "It's like a casino set up by the Communist Party." If the CCP isn't careful, they will find themselves in quandry (which they may already be in). A rising stockmarket keeps the public (especially the growing middle class) mollified and gives the CCP more credibility. On the other hand, a bubble that burst could cause widespread anger toward the CCP. As Western capitalists can attest to, it is rather difficult (if not impossible) to reconcile those two agendas.

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