The China stock index has risen steadily over the past year until now. The Shanghai Stock Exchange Composite Index closed at 2064 on 8th July 2014. On 12th June 2015, the index closed at 5166, posting a spectacular gain of 150%. The main driver of this gain is the availability of cheap and abundant leverage to retail investors. Unlike other developed stock markets, around 80%-85% of investors are mom-and-pop, most of whom are financially unsophisticated. To provide excessive leverage to this group of individual is irresponsible as it fuel speculations and encourages investors to make decisions solely based on technical rather than fundamentals.
It is true that with leverage, the rich gets richer, but conversely, with leverage, the poor also gets poorer.
To halt the market rout, the People’s Bank of China (PBoC) said it was helping state-owned China Securities Finance Corporation access liquidity to help the fund “hold the line against the outbreak of systemic or regional financial risk”. By doing so, it effectively means the state is buying shares directly using PBoC money, a big departure from its traditional role of lending to brokerages to support margin lending. This is a recipe for disaster as the government is bailing a selected group of individuals using the resources of the general public.