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Chinese stocks soar after a week of government rescue efforts

Xinhua/liu Xiao via Getty Images
  • China's Shanghai Composite index closed up 4.5 percent on Friday, the second straight day of big gains.
  • More than 1,400 companies — representing a majority of all companies traded on the mainland's two major exchanges — have halted trading in an effort to stop the previous days' slide.
  • China's leaders have taken a number of measures to reverse earlier price declines, including a Wednesday order banning companies' major shareholders from selling shares for six months.

Over the past year, the market surged due to borrowed money

Between June 2014 and June 2015, China's Shanghai Composite index rose by 150 percent. A big reason for the stock market rally was that a lot more people started buying stocks with borrowed money. This practice, known as "trading on margin," used to be strictly regulated by the Chinese government. But as the Financial Times explains, Chinese authorities have gradually relaxed these requirements over the past five years.

(Javier Zarracina/Vox)

During this period, the amount of officially sanctioned margin trading in the Chinese stock market ballooned from 403 billion yuan to 2.2 trillion yuan. Experts estimated that another 2 trillion yuan or so of borrowed money has flowed into the markets using vehicles designed to skirt official limits on margin trading.

The surge in stock prices alarmed Chinese authorities, and so earlier this year they took steps to rein in margin trading and other forms of leveraged investing. In January, they raised the minimum amount of cash needed to trade on margin, once again restricting the practice to wealthier investors. They also punished a dozen companies for failing to enforce rules on margin trades. The government cracked down on vehicles designed to skirt the margin trading rules in April.

The government's toughest measures came on June 12, when China's securities regulator announced a new limit on the total amount of margin lending stock brokers could do, while also reiterating the curbs on illicit margin trading.

After that, the market started falling, losing 32 percent of its value by July 7.

The government took extreme measures to reverse the declines

Last week, Chinese policymakers grew concerned that these efforts to rein in stock market speculation were working too well. With stock prices plummeting, the government took steps to try to prop them back up.

On Saturday, 21 major Chinese brokerages made a coordinated announcement, pledging to purchase $120 billion yuan worth of Chinese stocks to help stabilize the market. Chinese brokers vowed to keep buying stocks until the Shanghai index had risen to 4,500. Also, 28 privately held companies canceled plans to hold initial public offerings that could have drained capital away from companies that were already publicly traded. It's widely suspected that these moves were made at the behest of the Chinese government.

On Sunday, China's central bank also announced it would inject cash into the China Securities Finance Corp, a state-owned company that finances margin trading. In other words, the Chinese government is printing money to finance leveraged stock investment.

Between Monday and Wednesday of this week, about 1,400 companies — about half of those traded on China's two major exchanges — halted trading in an apparent bid to prevent further declines.

On Wednesday afternoon, in its most drastic step yet, the government banned major shareholders — those with more than 5 percent of a company's shares, as well as senior executives and board members — from selling their shares for a period of six months.

These measures have had mixed results. The Shanghai Composite gained modestly on Monday, fell modestly on Tuesday, and then lost another 5.9 percent on Wednesday.

But then the market rose 5.7 percent on Thursday, and gained an additional 4.5 percent on Friday. That left the markets up 5.1 percent for the week.

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