5 charts that explain why people are freaking out about the Chinese stock market

The Chinese stock market is in the news. And even though you probably haven't been day-trading Chinese stocks, it's a fascinating situation with potentially grave implications for the world's second-largest economy. This looks to a lot of people — especially smug foreigners — like a Chinese version of the stock market mania the United States experienced in the 1990s. A bubble, in other words, that's in the midst of popping. But financial markets are inherently unpredictable, so you should be wary of anyone who sounds too sure they know what's going on.

The Shanghai Stock Exchange plunged 7.4 percent yesterday

Bloomberg

It's been a bumpy month, down 19 percent since the market peak

Bloomberg

But on the year, Chinese stocks have soared

Bloomberg

The five-year picture just looks insane

Bloomberg

This seems to be China's version of the 1990s dot-com boom

So what's happening? Well, one should always be cautious about being sure you know what's happening in financial markets.

But broadly speaking, this looks a lot like a Chinese version of the 1990s stock market boom and ensuring mania in the United States. For a long time, even through China's miraculous multi-decade span of economic growth, Chinese households have been very cautious investors — either holding money in bank accounts or else parking in tangible real estate. Chinese people don't have a lot of experience with stock exchanges, and confidence in the markets was shaken by some so-called "fat finger" trading errors in 2013. But as the Chinese government began to take tentative steps to open up stock markets to foreign investors while simultaneously trying to discourage fevered real estate speculation, retail investors starting pouring in.

As retail investors poured in, Chinese stock prices went up. As Chinese stock prices went up, more people decided they wanted to get in on the action. It looked a lot like a bubble to most foreign observers. But there was also a belief that the Chinese government would keep trying to pile on stimulus to avert a market crash, and there's always the hope that you can trade your investment to a greater fool regardless of the underlying fundamentals.

But don't get too confident about a collapse

On the other hand, I should say that when I went to China in 2008 I heard from a lot of smart foreign observers that the country was in the midst of an unsustainable stimulus-driven boom that would surely crash someday soon. Now it's seven years later, and all the smart foreign observers say China is in the midst of an unsustainable stimulus-driven boom that's in the midst of collapsing. And since no country goes forever without an economic contraction, surely China really will see its long boom come to an end and the economy fall into recession one of these days. Maybe even tomorrow!

But it's dangerous to be too confident you know what's going on. Nobody really predicted the boom that's unfolded over the past six months, so nobody really knows what the future holds.

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