A stock investor reacts July 6 in front of a screen showing stock market movements in a brokerage house in Shanghai.

A stock investor reacts July 6 in front of a screen showing stock market movements in a brokerage house in Shanghai.

China’s stock market has plunged more than 30 percent over the past month. Yesterday, the benchmark Shanghai composite index fell another six percent. Chinese authorities have taken unprecedented steps to stop the slide, including ordering brokers to buy and shareholders not to sell. So far, nothing has worked and Chinese investors have lost tens of thousands of dollars. Some say the market collapse is just a correction from a bubble caused by margin trading and easy money chasers. Others say it’s a sign of deeper problems in the Chinese economy. We discuss the stock market crash in China and what it could mean for the ruling party and global economies.


  • Minxin Pei Professor of government, Claremont McKenna College.
  • Neil Irwin Senior economics correspondent, The New York Times; author of “The Alchemists: Three Central Bankers and a World on Fire" (2013).
  • Scott Kennedy Deputy director, Freeman Chair in China Studies, and director, Project on Chinese Business and Political Economy, Center for Strategic & International Studies (CSIS).


  • 10:06:53

    MS. DIANE REHMThanks for joining us. I'm Diane Rehm. China's stock market has lost a third of its value in the past month. Most investors are ordinary Chinese citizens who lost tens of thousands in the market collapse. Here to talk about what's causing the slide in China's stock market, what it could mean for the U.S. and global economies, Neil Irwin of the New York Times and Scott Kennedy of the Center For Strategic and International Studies.

  • 10:07:27

    MS. DIANE REHMJoining us by phone from Claremont, California, Minxin Pei of Claremont McKenna College. I do invite you to be part of the program. Give us a call at 800-433-8850. Send an email to drshow@wamu.org. Follow us on Facebook or Twitter. And thank you all for being here.

  • 10:07:53

    MR. NEIL IRWINHappy to be here.

  • 10:07:54

    MR. SCOTT KENNEDYThanks for having me.

  • 10:07:56

    MR. MINXIN PEIGlad to be here, too.

  • 10:07:57

    REHMNeil Irwin, let me start with you. What's behind this stock market crash in China?

  • 10:08:05

    IRWINWell, the most important thing to know is that behind this stock market crash over the last month or so there's been a remarkable stock market rally over the last year or so. Before June 12 when the recent high occurred, the market was up 150 percent. That's the Shanghai composite. It's down about a third since then, a little less than that thanks to a rally in Thursday's trading session.

  • 10:08:26

    IRWINSo what's happened is you've had these wild swings as there's been careening between excessive optimism, perhaps, and excessive pessimism about the future of the Chinese economy and Chinese businesses fueled by margin loans, ordinary Chinese citizens borrowing money to buy Chinese stocks, which both accelerates the gains and accelerates the losses when they occur.

  • 10:08:48

    REHMAnd are those ordinary citizens the likely ones to lose?

  • 10:08:54

    IRWINThat's right. You know, when you're buying a rocket ship stock like these Chinese stocks have been over the last year at very high valuations relative to their earnings, you're taking a lot of risk. And when you do that with borrowed money, with margin loans, you're taking even more risk. And so that's presumably wiping out quite a large number of middle class Chinese citizens right now.

  • 10:09:16

    REHMNow, Professor Pei, is it true that investing has become kind of a sport for middle class Chinese?

  • 10:09:29

    PEIWell, I think in the last year, yes. The Chinese middle class investors had a lot of very tough time in the stock market because the Chinese market has been in bad territory for about seven and a half years. So until only about a year ago did they start having some fun and now the fun is gone and is replaced by panic.

  • 10:09:55

    REHMSo what is it that the average citizen finds so appealing about putting all this money into the stock market and doing it very frequently on margin?

  • 10:10:11

    PEIYeah, I think most, probably, they have control of -- they have the illusion of control. It's liquid. Aside from the stock market, Chinese investors can only buy real estate and that's not a very appealing asset for them to have. On the other hand, they can go in big. They can go in small and they can see it on the screen every day.

  • 10:10:34

    REHMAnd to you, Scott Kennedy, what has the Chinese government tried to do or done to kind of alleviate this massive fall?

  • 10:10:47

    KENNEDYThey've done just about everything imaginable. The Chinese government is addicted to invention in markets and so at the first sign of trouble, they cut interest rates again. They made it so the banks could lend more. They encouraged the institutional investors, the securities companies not to sell stocks. The same for large state-owned enterprises. They just told the largest shareholders at state-owned enterprises and those largest firms that they shouldn't sell either. They suspended trading of about half of the companies on the exchange.

  • 10:11:23

    KENNEDYThey put together a fund to buy stocks as well. So really, they did everything but throw the kitchen sink at the problem.

  • 10:11:29

    REHMSo how come nothing worked?

  • 10:11:32

    KENNEDYWell, I guess it depends what day you are looking. Some days -- for the most part, it's looked horrible since June 12 when the crisis started. Last night or today in China, the Shanghai index was up almost 6 percent. The other market in Shenzhen was up around 4 percent so for them, that would be some type of indication that things have improved, but it's really only improved because they've tied the hands of all those companies which were likely to continue to go down.

  • 10:12:03

    REHMSo what they've said is you cannot sell. You've got to hold.

  • 10:12:08

    KENNEDYThat's right. And so it's a one-way bet at the moment.

  • 10:12:12

    REHMMinxin Pei, do you agree with that?

  • 10:12:16

    PEIOh, yes, I think Scott had it about right. But it's unlikely to work because half of the companies are suspended and these are the worst companies you would like to own. So the moment trading resumes in these companies, you're going to see another plunge. So I call this suspended avalanche. So you see this gigantic pile of snow that is going to come down at any moment.

  • 10:12:46

    REHMDo you agree with that, Neil?

  • 10:12:48

    IRWINI think that's right. You know, you can only fight the market for so long. If you eventually allow trading to occur, that'll change. A thing to remember, a lot of the strongest Chinese companies are not the core of what we're talking about. A lot of those, you know, if you want to invest in Ali Baba, the internet company, they're on the New York markets. A lot of these companies trade in Hong Kong.

  • 10:13:09

    IRWINThose markets are not down nearly as much because those have been more liquid, more mature markets to begin with and so the hit has not been nearly as great. What we're talking about are companies that, in general, have weaker accounting, weaker corporate governance, shakier finances. So that's part of what's driving this, is their pricing got out of control to begin with when they reached that peak last month and now, this is an adjustment that the government's trying to stop from happening.

  • 10:13:33

    REHMAnd what about the margin-buying? How much has that contributed to the rise and then the dramatic slide?

  • 10:13:43

    IRWINYou know, it's a very important part of the story. It creates this self-fulfilling thing on the way up. Stocks rise, people borrow more money to invest in them. They have tremendous profits because they used -- it was essentially a leveraged bet. It was a bet...

  • 10:13:56

    REHMWho are they borrowing from?

  • 10:13:57

    IRWINThe securities brokerage firms that are now under a lot of pressure from the Chinese government to try and keep the money flowing. So, in fact, they've been loosening margin requirements as part of the response to this, which is a sign they're trying to make it even easier to use borrowed money to buy stocks.

  • 10:14:12

    REHMDoes that make sense, Scott Kennedy?

  • 10:14:16

    KENNEDYIt's a really bad idea in the country where the stock market is more dangerous than gambling 'cause in gambling you know the rules and they usually stay the same. So we know when we play blackjack, it's about a 50.2 percent chance that we might do well if we make all our decisions right. In China, you really have no idea and basically, you're trying to look at the direction of government policy.

  • 10:14:37

    KENNEDYAnd when government policy looks expansionary, you jump in. When it looks contractionary, you get out of the way.

  • 10:14:42

    REHMSo Professor Pei, does that mean that even as people see the market sliding, they're still trying to get in on borrowed money?

  • 10:14:56

    PEINo. I think people -- right now, the only people who are buying are government entities. Slow time investors are not -- are getting to the market -- what's happening with the margin requirements is that brokers are not calling in margin loans, is that used to be the case if your stock portfolio falls below a certain percentage point, they just clear you out, liquidate the (unintelligible) portfolio and that generates some pressure.

  • 10:15:27

    PEINow, they're saying, it's okay. We can wait a bit longer. So that's helping to keep market up at least last night.

  • 10:15:36

    REHMBut now, how much has the ordinary citizen who's been putting money in and in and in lost in this dive?

  • 10:15:47

    KENNEDYWell, it depends when they bought and how much borrowed money they used. If you bought stocks a year ago and have held onto them and didn't use margin debt, you're still way ahead. You're still up 70, 80 percent, depending on the price you bought in at using the Shanghai index.

  • 10:16:01

    REHMAnd which stocks you bought into.

  • 10:16:04

    KENNEDYRight. So it's funny. It's, you know, I put it this way. The Chinese market is down 30 percent in the last month, but it's up 75 percent in the last year. That's a strange combination you don't see very often, but that's what we have right now in China.

  • 10:16:16

    REHMSo what does that mean, it's up, but it's down, it's down, but it's up?

  • 10:16:22

    IRWINWell, it's just, you know, it's a roller coaster. It's interesting that although it's down a lot, this is a lot of paper losses rather than something that's really hitting at the core of the economy. And households still have a lot of savings, a lot of money in real estate even though Minxin is correct that that's not as attractive an investment right now. But even if this market were to tank and go to zero, which it really physically couldn't do, but let's say it goes down another 50 percent, this is still a relatively healthy economy overall.

  • 10:16:58

    IRWINIt's not Greece. It's not Russia. It's not Argentina. But it does look really bad when you're in the middle of the storm.

  • 10:17:05

    REHMBut for those middle class Chinese who purchased on the margin and have now had those margin debts called in, what does it mean?

  • 10:17:19

    KENNEDYFor them, it's -- unfortunately, it means tough luck. But China is a very dangerous place to do business and especially in these type of markets because you think that the government will always be there to back you up and that creates this horrible moral hazard problem where they say, you know, if -- there is real risk and you'll lose if the market goes down, but they intervene and try to support things.

  • 10:17:46

    KENNEDYIn this case, it turned out that the government didn't have the capacity that they thought to keep the market afloat.

  • 10:17:53

    REHMScott Kennedy of The Center For Strategic and International Studies. Short break here. When we come back, your calls, comments, questions. I look forward to hearing from you.

  • 10:20:02

    REHMAnd welcome back. We're talking about China's stock market, which has lost a third of its value in the past month. Most investors are ordinary Chinese people. They've lost tens of thousands of dollars in the market collapse. Professor Pei, I'm just wondering what the role of the central government is in China, what it has done, what it should be doing.

  • 10:20:39

    PEIWell, the role of the central government is critical to the function of this entire system. In this case, the central government essentially plays the role of the buyer of the last resort -- the guarantor of the last resort. It simply guarantees outstanding debts in brokerage firms. It simply orders pension funds, which the government owns, it orders mutual funds, the government orders practically everything -- it owns a lot -- to buy. And it also has coercive power. It can order companies not to sell. It can order individuals not to sell. So right now, I think, it is the sheer force and power of this government that has temporarily stopped the panic, at least for a day.

  • 10:21:26

    REHMNow, how much separation is there between the central government and the central bank of China?

  • 10:21:36

    PEIWell, they're one and the same thing.

  • 10:21:37


  • 10:21:37

    PEIBecause the central bank of China is not the federal reserve. The head of the central bank of China is a member of the Communist Party. He used to be -- not the right one -- that person is a member of a central committee. He has minister-level rank. And he essentially does what the central government tells him to do. And, Scott Kennedy, what should the central bank, central government be doing right now?

  • 10:22:05

    KENNEDYWell, I think they've done about -- in terms of using all of the explicit interventionist tools, I think there's about nothing more that they can do. Really what they need to be thinking about is convincing folks that over the medium- to long-term, they have an economic reform plan in place that isn't about making short-term gains but about achieving economic growth that's built on efficiencies, productivity-improved environmental performance. One of the really interesting things about the intervention is that China's top leaders haven't said a word about this problem.

  • 10:22:46

    KENNEDYAnd in the United States, if there was a crisis where the market dropped 30 percent or anything like that, you know that President Obama and the rest -- and the fed chair and everyone else would be out talking about it.

  • 10:22:56

    REHMNobody's saying anything, Neil?

  • 10:22:59

    IRWINThat's right. You know, there's an idea that I think would be useful for the Chinese government to keep in mind. The stock market is not the economy, the economy is not the stock market. You want the government to worry about the economy, making sure people have jobs, have a good income, that the fundamentals of the economy -- whether it's China or the United States -- are sound. And focusing on markets can be a distraction from that. Now, markets matter, there's no -- of course, if the stock market drops a third in the U.S., you're going to have the fed chair, you're going to have treasury secretary having a lot of meetings and worrying about it and trying to figure out what to do.

  • 10:23:31

    IRWINBut if they're doing their job right, they're focused not on worrying about a 30 percent drop for its own sake, but because of what that might mean for spending, for investment, for the broader economy -- and focused on the long gain, not on trying to goose markets with some temporary interventions.

  • 10:23:45

    REHMAnd, Professor Pei, that's what you say the Chinese government ought to be doing right now, is putting money into the broader economy.

  • 10:23:57

    PEIOh, yes. This would be a much more effective measure, boosting confidence in the economy, rather than buying over-valued shares. I would say the Chinese government takes the stock market as a measure of its popularity. This is where the problem lies. This is not an elected government. So how do you gauge popularity in a more visible way and the view stock prices. So they -- their mistake is to view the whole situation as a political contest of will, rather than a bad economic policymaking.

  • 10:24:33

    REHMI'm not sure I understand that. What do you mean, it's a matter of will?

  • 10:24:39

    PEIWell, because they want to show -- this a government that has not lost any battle with markets or with its own people. So it wants to demonstrate that it has the capacity, has the will to fight this tidal wave of panic selling. And it's -- if it succeeds, establish itself as the most powerful government in history.

  • 10:25:04

    REHMBut how upset are the Chinese people right now?

  • 10:25:08

    KENNEDYWell, certainly, the 10- to 20-million Main Street investors who've lost a lot would be upset. And certainly, Chinese are known to complain vociferously, protest in front of securities firms, in front of local governments, even take their case to Beijing. Probably what the central government is more concerned about -- despite the fact that these folks are really loud and they also have the social media to complain through -- are state-owned enterprises that are listed on these stock exchanges, who've watched their balance sheets erode quite dramatically. And that money, that's the party's money.

  • 10:25:45

    REHMHere's our first email from Dominick. "What is the potential effect of the Chinese stock collapse on the American bonds that the Chinese government holds? Could they ask the U.S. to pay them the money we owe them?" Neil.

  • 10:26:05

    IRWINThat's not really how bonds work. You know, they own these securities that are issued by the U.S. government. And as long as the U.S. government matches its obligations, everything should be fine. But, you know, there's this broader question of how this might ripple across the Pacific to the U.S. and the broader global economy. I think, so far, there's not much reason to think this will. You know, the Chinese stock market is not massive by the standards of the global financial system. There are not a lot of foreign investors. It's almost entirely domestic investors. So the only way this really has ripple effects to the U.S. and the broader global economy is if it somehow gets out of the control of the Chinese government in terms of their economy.

  • 10:26:43

    IRWINAnd if this ripples through their financial system and causes credit losses and causes problems in their banking system, that could cause problems for us. Otherwise, it's hard to see how this exactly transfers through to problems in the U.S.

  • 10:26:56

    KENNEDYYeah. I'd agree. But I would just add that if Chinese households' consumer purchasing power goes down, that would have an effect on American exports. If Chinese can't invest in infrastructure and all the things that have driven Chinese growth over the last 15 years, that would have an effect on us. And if the Chinese government decided that they'd need to support the economy by devaluing the Renminbi to promote exports, that would also hurt our imports. But I would -- I agree entirely with Neil. The direct effect is amazingly limited compared to how you would think, given the size of the Chinese economy.

  • 10:27:29

    REHMProfessor Pei, what percentage of the Chinese people have invested in this bubble of a stock market?

  • 10:27:42

    PEIWell, this is not a -- probably (word?) no more than 20 percent of the Chinese population. Because of inequality in China, most people don't have money to invest. So this is a fairly affluent group. The people who have got into the market at the late stage are not the most affluent. These are the people who, unfortunately, have been hurt the most. So this is where things stand. I would say that there's one -- another way the Chinese crash can affect the U.S. That is, through capital outflows. You will have money pulling out of China. And that can affect the U.S. economy, probably in a good way somehow. Because the money will come to the U.S. So you don't have to worry about China not buying American bonds.

  • 10:28:45

    REHMDo you agree?

  • 10:28:47

    IRWINI certainly think that's one potential consequence. China does have capital controls, which limit, at least legally, how much money individual Chinese can send abroad. Already, there's been a larger transition in capital flows. China is still the number one destination in developing countries for direct investment. But it's now the -- one of the leading countries for outward direct investment and that's in the tens of billions. And so -- and I don't think that -- this might add to that, but I don't think it would be a fundamental game-changer.

  • 10:29:23

    REHMDo you agree?

  • 10:29:25

    KENNEDYYeah. And to combine two threads people have mentioned. If it is the case that they want to devalue the currency in order to stimulate exports and encourage job creation -- if that's part of their response -- that would mean, by definition, buying bonds, buying securities in the U.S. and in perhaps other countries. So, you know, it's a complicated mix of tools that could come to play that might actually lead to more investment in U.S. securities than they're doing now.

  • 10:29:53

    REHMProfessor Pei, I wonder about the political implications here -- whether, in fact, at least that portion of the Chinese population who have become investors are beginning to lose faith in the central government if it's not doing anything. And if they do lose faith, what's the outcome there?

  • 10:30:21

    PEIWell, I would say that if the central government is doing so much, it doesn't work, then they lose face. So, ironically, the central government has painted itself into a corner. Had the government not intervened at the very beginning of this market route, then it would not be blamed. So this is why, politically, it is not a very smart strategy, trying to do something that is so difficult.

  • 10:30:49

    REHMHow do you see it, Scott Kennedy?

  • 10:30:53

    KENNEDYI would agree. I think they really, in their own mind, thought that they didn't have any choice. Again, they're addicted to intervention and would not want to see where the market would end up on its own accord. But even despite this short-term problem, I mean, the party has a record of 36 years of continuous rapid growth, job creation. China's much more influential than it's ever been internationally. They also have massive coercive powers, control the media. This is not the number one story in China right now. So they have a lot of tools at their disposal to keep things relatively calm, unless the market continues to go down much more dramatically than it's gone so far.

  • 10:31:45

    REHMEven now, Neil Irwin, more tricks to use?

  • 10:31:51

    IRWINI don't know what they are. But I, you know, they've been very creative thus far in finding tools I didn't know they could deploy to try and prop up their market. You know, I would draw, you know, look, the nearest comparison in recent U.S. history is the dot-com bubble that popped in 2000, 2001. And, you know, not that the U.S. officials didn't make plenty of mistakes during that era...

  • 10:32:10

    REHMOh, boy.

  • 10:32:10

    IRWIN...because they certainly did. But they also didn't try and say that, "Oh, you know, these Pets.com needs to maintain its $80 share valuation and we're going to flood money into Pets.com to keep that from -- to keep that drop from happening. So, you know, focusing on the long-game and on the real economy, as opposed to manipulating markets by changing margin requirements and funneling money through pension funds and things into the market, I think is -- they're created a risky game where, as Scott said, they now -- if they lose this battle, which the fundamentals what they are, they probably will eventually -- it ruins their credibility because they've made this such a first order of concern.

  • 10:32:49

    REHMHave they already gone too far, Professor Pei?

  • 10:32:54

    PEII think they have because stock market investing is a long-term gain. And by, as Scott said, by showing such a heavy hand of the government, they are going to destroy long-term confidence in the stock market. So in terms of economic reform, they actually have turned back the clock. So that's why the market intervention, itself, will have very serious and negative long-term consequences.

  • 10:33:23

    REHMHow long is it going to take to correct this situation? Scott Kennedy.

  • 10:33:32

    KENNEDYWell, I think in terms of the market bottoming out and stabilizing, it's really hard to say. It could be a few more weeks, it could be a few more months. You know, I'm probably a little bit more optimistic than my fellow panelists in terms of the fundamentals of the Chinese economy, in terms of the overall direction of where it can go. Now, this isn't a leadership that is going to base bringing it in a positive direction just on markets. They're going to use a whole variety of tools and never give that up.

  • 10:34:07

    REHMAnd you're listening to "The Diane Rehm Show." We have a number of callers. We'll go to the phones now. First, to Sandra in Detroit, Mich. You're on the air.

  • 10:34:24

    SANDRAWell, hi, Diane.

  • 10:34:25

    REHMHi, there.

  • 10:34:26

    SANDRAI was thinking that the Chinese should remember, and also Americans, to -- that if their stock gets too high in relation to its earnings, they're bound to have some sort of a correction. And so they should just keep that in mind when they do their investing.

  • 10:34:50


  • 10:34:50

    IRWINYeah. I think that's right. You know, and you look at the very simplest measure of fundamentals, which is the price-to-earnings ratio, at the peak, the Shanghai composite index's price-to-earnings ratio got to 25. Meaning, you had to pay $25 for a share that yielded $1 in earnings each year. That's about as high as the U.S. market got during the dot-com bubble. That's very high by any historical standards, especially when you account for the fact that interest rates are higher there than they are here. Now, that's fallen to about 18. That's the same kind of price-to-earnings ratios you have in the U.S. market. Now, they have higher interest rates, so maybe that isn't as well justified.

  • 10:35:24

    IRWINBut the fact that you were at that very elevated level suggests that this adjustment we've seen is not hard to justify. You know, this drop over the last month gets valuations more into a plausible, normal range than where they were on June 12.

  • 10:35:37

    REHMSo does that mean you'll see an exit from the stock market gamble, if you will, from that 20 percent of the public?

  • 10:35:50

    IRWINWell, the question is whether there are psychological effects that go beyond the fundamentals. Is there an overshooting, for example? Whatever the proper level, the fair level evaluation for the U.S. -- for the Chinese stock market is, is the psychology such that now all these investors want nothing to do with it and there's margin calls and there's all these bad things that lead to an overshooting the other direction. The government's doing everything it can to not let that happen. But that's a possibility.

  • 10:36:14

    REHMWhat do you see happening? Scott.

  • 10:36:17

    KENNEDYThe government just taught the Chinese people the lesson that, even if the market goes down, we will be there for you. There is one organization with credit in China, and that's the Communist Party. And even if they fly too close to the sun and folks don't follow Sandra's advice, they will continue to play in this market. They don't really have a whole lot of other options. And they really believe that the Party will be there to rescue them, even if they shouldn't.

  • 10:36:43

    REHMEven if, say, individual investors suffer real losses? How does the government help them?

  • 10:36:54

    KENNEDYIt doesn't. It will provide an -- I guess that's not -- they'll provide expansionary credit policies and monetary policies and other types of stimuli. And they're trying to build a better safety net, a health-care system, improve education.

  • 10:37:08

    REHMBut you're saying individual investors...

  • 10:37:10

    KENNEDYBut, no. They just have to hope that, if the market goes up and they get caught, that there'll be some type of rescue for them.

  • 10:37:20

    REHMAll right. We'll take a short break here. When we come back, more of your comments, your questions. I look forward to speaking with you.

  • 10:40:02

    REHMAnd before we return to the questions about the Chinese stock market, I'd like to ask you, Neil Irwin, whether we know anything more about what could have triggered the closure of the New York Stock Exchange. Is there any evidence, whatsoever, of a cyber attack?

  • 10:40:26

    IRWINWell, the New York Stock Exchange says that's not the case. This was a technical problem. The law enforcement authorities say the same. So, unless there's something they don't know or they're not telling us, it looks like this is a technical glitch. It was an odd day yesterday on markets, because you had this world, we have Greece on the verge of leaving the Eurozone possibly, we have the Chinese stock market collapsing and suddenly we have the New York Stock Exchange shutting down for a few hours.

  • 10:40:51

    REHMAnd United Airlines and the Wall Street Journal.

  • 10:40:51

    IRWINUnited Airlines. Even the Wall Street Journal home page. So, it just created this weird, you know, maybe none of that will have lasting effects on US markets or the US economy, but it sure felt scary for a few hours there yesterday even if it was all unrelated.

  • 10:41:06

    REHMI want to know, honestly, if you have any doubts about what has been said.

  • 10:41:13

    IRWINI, you know, I have no basis to judge. I don't know a lot about cyber security or what might have happened. But we know, you know, these critical systems are out there and have been more exposed than we would like to see in the past.

  • 10:41:27

    REHMOut there in Claremont, California, Professor Pei, what was your reaction?

  • 10:41:34

    PEIWell, yesterday, I saw there could be no connection between what happened in China and what's going on in New York Stock Exchange, because the rumors were spreading that China might have engineered some kind of a cyber attack and I thought that was nonsense. Because the Chinese government would never have contemplated something of this nature, especially because the Chinese President is coming to the US. In September, why should he try to do something that will lead to the cancellation of his visit?

  • 10:42:12

    REHMSo, you have no doubts that this was total coincidence.

  • 10:42:20


  • 10:42:21

    REHMAnd you, Scott Kennedy.

  • 10:42:25

    KENNEDYYou never know. There could be some rogue organization in China, in the military, that wanted to play games. But the chance that this was directed from on high, from China, would be highly, highly unlikely given what Professor Pei said. And I think the most likely answer is the most obvious one, and it's what they claimed yesterday.

  • 10:42:48

    REHMAll right, here's an email from Joel in Dallas, Texas. He says, this aggressive, margin speculation sounds exactly like what brought down the US stock market in 1929. Is this a similarly dangerous situation in a huge economy? And if not, how is it less dangerous? Professor Pei?

  • 10:43:18

    PEIOh yes, I think this is true. We didn't talk about the role, the amount of margin loans in this whole (unintelligible) At its peak, anywhere between 10 to 25 percent of the market value was supported by margin loans. So, margin loans played an enormous role in this run up of the market and also the route of the market. But, so far, I think because of the temporary measures the government has done, margin, the banking sector has been protected. Because about four trillion euro are in the market, only a half of the banking sector and the (unintelligible) banking sector. So, this -- it's huge, but it's not that, it's not as devastating as you might want to think.

  • 10:44:14


  • 10:44:15

    IRWINI would just add, the Great Depression became the Great Depression not because of a stock market crash. That was just the precipitating event. The key is that stock market crash then had pathways through the banking system that led to a broad freeze up in credit in the early 1930s in the US and in Europe. Similarly, in this last crisis in the US, it was -- it started with sub- prime housing, but that was just the trigger, and it really propagated through the banking system, through the credit system.

  • 10:44:40

    IRWINSame here. There's no inherent reason this crash in this Chinese stock market has to become a broader recession or broader economic problems. That said, it could if it travels through the right credit channels, through the broader economy.

  • 10:44:52

    REHMAll right, let's go back to the phones to Mark in Charlotte, North Carolina. You're on the air.

  • 10:45:00

    MARKGood morning, Diane.

  • 10:45:01


  • 10:45:02

    MARKI'm just wondering, from a retiree's perspective, for those of us who've been encouraged to invest in international stocks, the prospectus looks like most of those are stocks that are traded on the New York exchange. Although, sometimes hard to figure out. But wondering the degree to which we have some exposure in this trouble in China.

  • 10:45:26

    REHMScott Kennedy.

  • 10:45:28

    KENNEDYLuckily, not a lot. There are -- about four percent of China's stock markets are from foreign money, overseas capital, but they have to -- the only way they can get in is being called qualified foreign institutional investors. And so, maybe mutual funds that you might invest in might have some of their money in there. But the primary way, that, in least in terms of securities that you and others are exposed to China are through safer ways. Companies that are listed on NASDAQ or the New York Stock Exchange.

  • 10:46:03

    KENNEDYOr if you invest in commodities markets through futures exchanges. But those are safer overall. And the large drop that we've seen in the Chinese domestic markets has not been translated into big drops in China connected stocks overseas, including in the United States.

  • 10:46:24

    REHMAt the same time, we have seen some pretty big swings in our own stock market in the last few weeks, whether that's been about Greece, whether that's been about China. I mean, put it all together, and you've seen lots of rollercoastering.

  • 10:46:42

    KENNEDYOf course. Of course. I mean, our job today, and on no day, is to dispense investment advice. But, and of course, things are always risky and different investors have different levels of risk tolerance. You just always want to be very careful, and of course, as China is a developing country, with, as we've seen, far from perfect governance institutions, and decision making, you want to be super careful about that. Even for your average investor that has a high tolerance for risk, you need to know everything possible going in.

  • 10:47:18

    REHMSo, what's been the main driver of the rollercoaster on the US stock market, Neil?

  • 10:47:25

    IRWINWell, I think it's all these things combined. Greece and what will happen with Europe. The Chinese sell off certainly doesn't help. But, you know, fundamentally, you have to remember, the US is a pretty resilient economy. And in normal times, when the US economy is healthy, it can weather international shocks. You know, in the late 90s, you had an east Asian financial crisis that encompassed a lot of countries over there. And the US economy grew like gangbusters in 1999.

  • 10:47:51

    IRWINThere's no reason, there's no inherent reason that a slowdown in China has to infect us and cause a recession or a slowdown. That said, people, you know, we're so fresh from the memory of the crisis and the deep recession and the very sluggish recovery that I think people are nervous. And people, you know, look around the world, see all the things that are going wrong in different countries and say, well, is one of those going to cause another downturn here? And that helps explain some of the jitters.

  • 10:48:13

    REHMAnd Professor Pei, here's a comment from our website. Will the Chinese leaders go after enemies, even more aggressively to divert public attention if the Chinese economy goes in to the tank, or even just slows below levels people have come to expect?

  • 10:48:40

    PEITempting, but unlikely. Because the Chinese government is run by very pragmatic people. And also, relatively risk averse people. And when you look around China's borders, there are not many countries it can go after. Most of Chinese neighbors have nuclear weapons. You don't go after people with nuclear weapons. And then, you don't go after people with strong military. And all the Chinese neighbors have some, most of the neighbors China can actually get into a fight with have some kind of security arrangements with the US.

  • 10:49:17

    PEISo, if you become aggressive, that means you are going to deal with the US. So, I tend to dismiss that kind of worries as well, reasonable but unnecessary.

  • 10:49:31

    REHMAll right, to Pittsboro, North Carolina. Joshua, you're on the air.

  • 10:49:37

    JOSHUAThank you. I have a question about the ordinary Chinese investor who borrowed money to get into the stock market. Are those loans collateralized? If so, how, and what happens if and when those loans are called?

  • 10:49:48


  • 10:49:49

    IRWINWell, the way margin loans work, they're collateralized by the shares you're buying. So, that's part of this self-fulfilling cycle where, when stocks drop, suddenly there's a margin call, and that's essentially, you're being ordered to come up with your collateral, and that's where you get this cycle of selling. In a normal environment. You know, in the US, when you have a downturn, you'll see a margin fueled selling is what the commentators all will talk about. What's happening that's unusual in China right now is the government's trying to stop that cycle from setting in by relaxing margin rules, margin requirements at the very time they're happening.

  • 10:50:24

    IRWINYou know, that said, are there other types of loans out there that are collateralized? Well, people used residential loans and funneled that money. You know, there could be things out there. But fundamentally, this is, this is about margin debt, and that's collateralized by the shares themselves.

  • 10:50:39

    REHMScott, do you want to add to that?

  • 10:50:41

    KENNEDYI think that that's quite right. You know, we also need to remember the Chinese have a lot of savings. They're the largest savers in the world, because China has a very expensive healthcare system. They don't have universal healthcare. They have to pay a lot for education and other things. So, they're gonna -- a lot of investors are going to lose a lot, but most of them are still going to have something left over.

  • 10:51:05

    REHMNow, Professor Pei, I think you have, for the most part, answered this question. However, we have an email that says, why is China's involvement in the IT failure so impossible? When a nation is in turmoil, creating a diversion is an excellent subterfuge.

  • 10:51:33

    PEIWell, I think this is a myth. This is urban myth about how governments behave. I, as an academic, I actually have looked into this issue. You, throughout history, lots of governments have had domestic turmoil. But you will find, perhaps, on the, no one attempts instances, perhaps even fewer of governments actually try to lash out when they are -- own country is in turmoil. The only most recent instance is Argentina. 1983. It invaded a small island called Falklands.

  • 10:52:16

    PEIOther than that, I really cannot come out or come up with another reasoned instance.

  • 10:52:23


  • 10:52:24

    PEIThat's why I tend to view this kind of talk as...

  • 10:52:28

    REHMUrban myth.

  • 10:52:30


  • 10:52:30

    REHMYeah. Scott.

  • 10:52:31

    KENNEDYI would agree with Pei, but I would also say that Xi Jinping is comfortable with chaos under heaven. And he's got a much higher tolerance for risk than the previous leadership. They anti-corruption campaign, targeting lots of domestic opponents, making a lot of risk, and that's partly why they needed so much stimulus to get the economy moving. Internationally, China's been quite active in the South China Sea on cyber and elsewhere. Actually, what the, the logic is actually the reverse of the questioners comment. And that actually, China now, needs to kind of cool things a little bit domestically and internationally.

  • 10:53:10

    KENNEDYBecause they do have serious economic issues they need to deal with. And those problems that they have internationally are only going to get in the way of them addressing these issues.

  • 10:53:19

    REHMSo, are you saying that because they need to cool things internally, the risk of doing mischief externally may be greater than Professor Pei thinks?

  • 10:53:33

    KENNEDYNo, I agree with Professor Pei entirely. I think that now, after a few years of making mischief and trying to expand China's international influence, with these type of economic problems, with the tensions it's generated with the US and others, there's a higher premium now on them trying to make good with the US and others to address these problems.

  • 10:53:56

    REHMAnd you're listening to The Diane Rehm Show. And to Herman in Tampa, Florida. You're on the air.

  • 10:54:07

    HERMANYes, good morning. Yes, I just learned that Pugh research says there is a rise in the middle class worldwide, but 50 percent of that rise has been in China. I would like to know what is the correlation between the decrease of the middle class in the United States and Europe and this increase of 50 percent in China.

  • 10:54:29

    REHMWhat do you think, Neil Irwin?

  • 10:54:31

    IRWINThey probably are related in some ways. You know, this has been a remarkable story, the last three decades, for Chinese people who were really destitute, you know, 25 years ago, are now comfortably in the global middle class. Can feed themselves comfortably and live in a comfortable apartment. That's a wonderful story. It's also the case that this has been a very difficult couple of decades for kind of working class people in the advanced world. So, you've seen downward pressure on incomes of workers without a lot of education in the US, in western Europe, in Japan.

  • 10:55:03

    IRWINAnd those probably are related. Probably the rise of the industrial sector in China and other emerging markets and the lower wages in those areas are probably a factor in downward pressure on wages in the west.

  • 10:55:15


  • 10:55:15

    KENNEDYYeah, I think Neil's correct, to some extent. But, most of the problems that the middle class in the United States have been facing, the past three years, are self-induced by government that hasn't invested enough in our own infrastructure, in education, in healthcare. And I think, in general, international trade and investment, including with China, has been a net gain for Americans, consumers, and even most of our workers. Of course, there are some sectors and industries that have, whose jobs have been moved abroad.

  • 10:55:44

    KENNEDYBut on balance, it's been a net positive, and most of the challenges are things that we brought on our self.

  • 10:55:50

    REHMNeil Irwin, how do you see this playing out? Do you see the China stock slide ending soon?

  • 10:55:59

    IRWINYou know, there's nothing more dangerous than trying to predict short term movements in financial markets, so I won't do it here. You know, I think the question is fundamentals verses psychology verses government intervention. And those three things are all at cross purposes. The fundamentals would say maybe they have a little further to fall, maybe not. Maybe they have a lot further to fall. That's hard to know for sure. Psychology would suggest if people's psychologies really turned, who knows what happens when some of these stocks that aren't trading at all right now when they reopen.

  • 10:56:28

    IRWINAnd then the government that's so dedicated, so focused on trying to prop this thing up. And which of those forces prevail is anybody's guess, so that's why I'm reluctant to predict.

  • 10:56:36

    REHMAnd to you, Professor Pei. Very quickly. How much longer?

  • 10:56:42

    PEIWell, I don't know about longer, I know the direction. I think it will still have a lot of room to fall. How long it takes, we do not know. But if we have to say six months from now, will the Chinese market going to be higher or lower, I would say it will be lower.

  • 10:56:56

    REHMAnd you, Scott Kennedy.

  • 10:56:59

    KENNEDYI'm going to be as cautious as Neil. I think the real question is will the Chinese government continue to advocate strong economic reformist policies or are they going to pull back because of the worries that have been raised in the last month?

  • 10:57:11

    REHMScott Kennedy, Neil Irwin, Minxin Pei. Thank you, all, so much, for being with us. Gonna watch this very closely. Thanks for listening, all. I'm Diane Rehm.

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