Over the past 3 weeks, Shanghai Composite Index has fallen over 30%. Frustrated by the deep sell-off in the equity market, China responded with massive stimulus packages to save the equity market. In this year alone, PBoC have cut their interest rate by 4 times and lower their reserve requirement ratio by 50bp.
Between July 2014 and mid June, the Shanghai Composite index rose 150%, mainly thanks to the infamous shadow banking. The recent 30% correction, in my opinion, is natural after a sharp rise, as long traders and investors close out their positions to lock in profits.
You see, when the economy is experiencing slow down, most governments tend to pump in more liquidity in the market by easing the monetary policy - lowering interest rate, lowering reserve requirement ratio, doing quantitative easing, etc. to prop up the economy. Japan did it. US did it. UK did it. Eurozone did it. China did it. Australia did it. And without surprise, New Zealand is soon to lower their official cash rate by 25 basis point to 3%
In my humble opinion, it might help to lift the economy in the short term, but it will do more harm than good in the long run, if the debt is not managed properly. By pumping more money to the market, the government is literally expanding the country's balance sheet, increasing public debt, inflating the debt bubble. And they do it at our expense.
Because eventually who are going to pay the bill? The citizens.
We'll be taxed more to increase the government revenue to pay for the money we borrowed.
But why does the government do it?
Because it's always in the best interest of the politicians to show us that the economy is doing well, unemployment rate is low, wage growth is good, inflation is moderate, so that they can be re-elected next term. So they have to borrow more future money to spur the current economy slowdown to show that, "Hey look! We have managed the economy so well. Vote me next term."
That's how the debt bubble is inflated.
We ought to understand that the economy moves in cycle - full recession, early recovery, late recovery, early recession. I think it is only healthy for an economy to correct by itself. Sometimes, less government intervention will do more good than harm.
