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China's stock market crash, explained in charts

China's benchmark Shanghai Composite index fell 1.2 percent on Wednesday, the fifth straight day of losses. Here are 11 charts that show some of the economic forces driving China's stock market turbulence.

1) The stock market has lost 43 percent since June

China stock market

(Javier Zarracina/Vox)

Between June 2014 and June 2015, China's Shanghai Composite index rose about 150 percent, reaching a high of 5,166 on June 12. Then the bottom fell out of the market. In less than a month, it fell to 3,507 — a 32 percent decline.

A series of extraordinary interventions by the Chinese government helped stabilize the market and push it back up to 4,000. But the reprieve was short-lived. Over the last five days, the market has lost more than 20 percent of its value; the Shanghai Composite closed at 2,927 on Wednesday.

2) The Chinese government's efforts to stop the crash have failed

(Financial Times)

This chart from the Financial Times shows some of the key developments of the past two months. It also points to one possible trigger of the current market rout: a decision by the Chinese Securities Finance Corporation to stop injecting funds into the stock market.

China's central bank had used the CSFC as a conduit to help Chinese people buy stocks with borrowed funds, helping to prop up stock market prices. The authorities probably hoped that after a month of doing this, the stock market had stabilized enough to make further support unnecessary. The market, however, had other ideas.

3) China devalued its currency earlier this month

Chinese currency depreciation

(Visual Capitalist)

One sign that China's government was worried about its slowing economy was a decision to devalue its currency. Since 2009, rapid growth in the Chinese economy has pushed the value of the yuan up relative to the dollar. But then the slowing Chinese economy started to push the yuan downward.

China's central bank intervened in foreign currency markets to maintain the yuan's value, but on August 11 it decided to let the currency drop by about 3 percent. In theory, this should have provided a boost to the Chinese economy by making Chinese exports more affordable to foreigners. But this wasn't enough to prevent further declines in the stock market.

4) China's economic growth is slowing

(Javier Zarracina/Vox)

China's official inflation-adjusted growth rate in 2014 was 7.4 percent, and the economy grew by 7 percent in the first quarter of 2015. If the United States grew at a 7 percent annual rate, it would be considered a huge accomplishment.

But even after two decades of rapid economic growth, China is a lot poorer than the United States. China needs to continue growing rapidly for a couple more decades to catch up to the developed world — and maintain the legitimacy of China's authoritarian political system. The Chinese economy grew at around 10 percent for years for much of the 2000s. So growing at "only" 7 percent a year is seen as a disappointment.

It's worth taking official Chinese economic figures like these with a grain of salt, since even some Chinese officials have privately admitted that they're unreliable. That might explain why we've seen so little volatility in the official figures in the past few years.

5) China is going through its second boom-and-bust cycle in a decade


From 2005 to 2007, China's benchmark stock index, the Shanghai Composite, grew sixfold, from 1,000 to 6,000. Then the market crashed, falling below 2,000 by the end of 2008.

The cause of this earlier boom-and-bust cycle was obvious: The Chinese economy was growing extremely rapidly in the mid-2000s, so stocks went up. Then the global economy started to implode, so Chinese stocks crashed along with stocks everywhere else.

The latest boom, which started in June 2014, is different. It didn't coincide with particularly strong economic growth — the economy actually grew more slowly in 2014 than in 2013 or 2012.

6) China's latest stock market boom was fueled by debt


In the past couple of years, Chinese regulators have relaxed strict limits on buying stocks with borrowed money. As a result, the volume of "margin trading," as it's known, has soared. By the time the stock market reached its peak in June, people had bought 2.2 trillion yuan ($350 billion) of mainland stocks with borrowed money.

And this figure likely understates the role of borrowed money in China's latest stock market boom. Because in addition to officially sanctioned margin trading, Chinese investors have found a variety of ways to covertly invest borrowed money — perhaps another 2 trillion yuan ($320 billion) — in the stock market.

7) China has zoomed past the US on margin debt

(Javier Zarracina/Vox, based on Macquarie Research, via Bloomberg)

A good way to gauge the significance of margin trading is by comparing it with "free float." This term refers to shares that are available for public trading — as opposed to stock that's locked up by corporate executives, the government, or others.

When margin debt is large compared with free float, it's a sign that borrowing is having a big impact on stock prices. In the past, strict regulations on margin trading meant that China had much less margin debt than other countries. But in the past couple of years, margin debt has skyrocketed. Today, margin debt is much larger, relative to the overall size of the stock market, in China than in the US or Japan.

8) The 1929 stock market bubble was also fueled by debt

(Mark J. Lundeen)

It's not unusual for stock market booms to be fueled by borrowing. Indeed, borrowing played a prominent role in one of the most famous stock market bubbles — and subsequent crashes — in history: America's in the late 1920s.

America in the 1920s, like China today, had a workforce that was rapidly becoming more educated and urbanized. This was when stock trading first became a mainstream phenomenon, and when ordinary people discovered the idea of trading stocks with borrowed money. The result: a huge stock market boom between 1926 and 1929, followed by a stock market crash and the worst economic downturn in American history.

9) Ordinary Chinese have been getting into stocks in droves

(Javier Zarracina/Vox, based on a chart by KKR and data from China Securities Depository and Clearing Corporations and Bloomberg)

This chart shows the number of stock trading accounts that have been opened in China over the past decades. As you can see, there was a big jump in new accounts as the stock market jumped in 2006 and 2007.

But in late 2014 and early 2015 China saw a much bigger surge in new accounts being opened. More than 40 million accounts were opened between June 2014 and May 2015. In total, there are now more stock traders in China — 90 million — than members of the Communist Party.

This helps explain why China's leaders are panicking over the stock market's decline. A stock market crash will not only affect those 90 million people, it will affect their friends, family, and neighbors, and could trigger widespread anger at the government.

10) Wealth management products are getting more popular — and riskier


Recent years have seen the growth of wealth management products in China. Originally these financial products were akin to money market funds in the United States, investing in relatively safe assets and offering Chinese savers a higher return than they could get with a traditional savings account.

But as the WMP market has gotten more competitive, banks have faced pressure to boost returns. This chart shows the result. Not only are there a lot more WMPs being sold than five years ago, but banks are offering their customers higher returns. In 2010, most WMPs offered returns of less than 3 percent. Today, most return 5 percent or more.

But to achieve these higher returns, banks have been doing riskier things with WMP funds. They've loaned them to real estate developers or others engaged in risky projects. They've used them to invest in stocks directly. And in some cases, they've effectively loaned the funds to others who want to invest in the stock market.

If the economy does well, this kind of gamble can work out fine. But as stocks fall and the Chinese economy falters, there's a danger that WMP investors will start losing their money. And that's a problem because many consumers believed WMPs were safe investments akin to a savings account. They're not going to be happy if these supposedly safe investments start producing losses.

11) Chinese trusts are making highly leveraged bets

(Yan Liang, based on IMF data)

This practice of making investments with borrowed money is known as leverage, and it's not just individual Chinese investors who are doing it. Trusts are a bit like American investment banks or private equity funds: They provide investment opportunities for wealthy clients. And in recent years, they've become a popular way for those clients to evade limits on buying stocks with borrowed funds.

This chart from Willamette University economist Yan Liang compares trusts' equity — the value held by the firms' shareholders — to the total value of their "assets under management." When this ratio is high, it means that the firms are investing with borrowed funds, making them highly vulnerable to market volatility. Liang calls a ratio of 40 to 1 "dangerously high," because a small decline in asset values can wipe out the owners' equity.

This kind of thing was a major factor behind the US financial crisis in 2008: US investment banks became highly leveraged, leaving them with little margin for error when the housing market imploded.

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