China Economic Collapse: A Dire Warning for China’s Stock Market

China Economic CollapseAre We on the Verge of a Chinese Economic Collapse?

As many of you know, I’m a longtime believer in China’s growth thesis, but I also feel the road over the next few years will be marked by potholes. In the best case scenario, we can avoid a Chinese economic collapse. Realistically, though, you have to wonder.

The Chinese economy has stalled with its economy expanding at around 6.7% depending on whether you believe the metrics out of Beijing are truthful. My thinking is that China is probably growing at the low six percent level or even below. Some China watchers have a wide range spanning as low as 3.5% to 6.5%.

The concern is that the inability to rely on the actual growth metrics for the Chinese economy is dangerous not only for China but also for the global economy, including the U.S. What happens if the real growth in the Chinese economy is way lower at below six percent? This would drive massive distrust towards Chinese economic data and anything out of Beijing. The impact on the global economies and stock markets would be disastrous.

The only certainty now is that China is spending trillions on artificially propping up the Chinese economy and stock market.

The country’s financial system is not trustworthy. Beijing dictates the rules on how the banks operate, whether it’s changing the loan or reserve requirements or even forcing banks to adapt to rapidly changing regulations.

This Could Spark China’s Economic Collapse

Make no mistake about it, while I like China as a growth region, you can’t ignore the risk investing in Chinese stocks.

Domestically, the Securities Exchange Commission (SEC) has largely cleaned up the financial fraud shown by numerous Chinese companies listed on the major U.S. stock exchanges. Yet you will still find some of these sketchy Chinese stocks trading on the less regulated Pink Sheets and over-the-counter market.

Can you imagine the kind of financial fraud that can occur on the two Chinese exchanges such as the Shanghai Stock Exchange or Shenzhen Stock Exchange?

The lack of strong Chinese stock regulation and oversight has created mistrust towards Chinese stocks for Western investors who know the numbers could be fabricated. Other than some of the larger Chinese companies, such as those found on the iShares China Large-cap ETF (NYSEArca: FXI), you have to approach with extreme caution.

But a scarier event will occur around April 11 when the temporary restrictions on trading put into place on January 9 will expire, which has many investors nervous. The restriction prevented large shareholders from selling more than one percent of a company’s total stock in order to provide some stability to Chinese stocks and avoid a bigger collapse at the start of the year.

The strategy has worked, as Chinese stocks have been flat this year, but you have to wonder what will happen when restrictions such as these are lifted.

The reality is there are still hundreds of smaller Chinese stocks that are not allowed to trade, in fear of a massive sell-off. Many unsophisticated investors hold these stocks and have watched their life savings disappear into thin air…and there’s nothing they can do. If the trading freeze is lifted, we can expect to see a swarm of selling frenzy emerge, which has the regulators and Beijing very nervous.

What I expect will happen is that the Chinese government will offer some sort of reimbursement for some of the losses in a take-it-or-leave-it option. The bottom line is that while China remains an intriguing place to invest, you also need to be extremely careful when looking at the economic data and Chinese-listed stocks.

Even worse, a Chinese economic collapse will spread like a virus around the world. This is a real concern.