It’s never a good sign when you get unsolicited investment tips at a stand in a bustling street market. This is what happened to me twice in five years. The first time was during China’s unprecedented stock market rally in the spring of 2015, fuelled predominantly by what banks call retail investors, or “mom-and-pop” investors, that is to say, private investors who play the market.

An elderly lady who used a contraption with four different lenses over her ordinary glasses to fix tiny machines looked up to tell me to “get into the stock market.” She added that “as a foreigner,” I must have had spare cash lying around. Maybe the fact that I wore a suit also gave her that (wrong) impression.

Photo: GovHK.

I am glad that I did not “get into the stock market.” In June 2015, the rambunctious markets tumbled, wiping out seven trillion yuan in a matter of weeks and created the first existential threat to incumbent Chinese leader Xi Jinping’s rule. Some people point to the crash as one of the defining moments of the Xi Era, one which nudged him towards his Marxist approach: that of repression and managing markets.

Even Bloomberg Chief Economist, Thomas Orlik, in his book China: The Bubble that Never Pops about the poorly managed stock market crash of 2015 wrote that China’s reputation was in tatters: “China’s maladroit reaction to the equity meltdown had pulled back the curtain, revealing regulators that were no better equipped to deal with a crisis than their counterparts in the United States had been in 2008.”

This, in a book with such a hubristic title, is a reminder of how serious things were at the time.

Still, with severe capital controls and low returns on savings, Chinese investors are always willing to bet on the next big thing. I was given another “golden tip” at the biggest cloth market in northeast China. A tailor I frequent for blazer adjustments told me to buy Luckin Coffee.

This was last June. I had only seen Luckin stores in coastal cities, not in the frigid northeast where I lived at the time. I asked him where I could buy the coffee, but it turned out he was just giving me friendly “between-measurements” stock market advice. Again, I was sceptical if a tailor with a deft hand with needle and thread would be just as deft at identifying an investment opportunity.

File Photo: Wikicommons.

Unlike the rather generic advice to “get into the stock market,” Luckin was and is a real company, with brick-and-mortar coffee shops, decent coffee, and a very nice app to pre-order your drink of choice. A proposition backed by a product that I could see, touch, and even taste seemed safer than quite a few other offspring of the Chinese communist chimaera that is made up of free-market economics and orthodox Marxism.

In two and a half years, Luckin rose from nothing to become China’s biggest coffee chain with 4,500 shops, outnumbering Starbucks in the world’s most populous country. The company debuted on the Nasdaq last May with a US$561 million initial public offerings only 18 months after its founding.

In just six months, Luckin’s market value shot up more than 20-fold to nearly US$12.5 billion. If I had listened to my tailor and gotten out within those six months, I could have afforded more than a number of very nice suits.

What sharing bicycle platforms had been only a brief moment ago was now the great taste of coffee and pastries. Investors should have learned from the breakneck speed at which bike sharing companies tried to conquer the market and woo investors.

Between June and November 2017, Kuqi Bikes, BlueGoGo, Dingding Bikes, 3VBikes, and Wikong Bycycle all went under, leaving the streets cluttered with permanently abandoned bikes. This was what lay in store for Ofo, the largest of the bike sharing companies to go bust and leaving users – such as me – holding the bicycle bag with a deposit gone forever.

Photo: Tom Grundy/HKFP.

Where Ofo tried to expand too quickly too fast, Luckin Coffee went a step further and inflated its own enormous expansion by fiddling with the numbers. On April 2 of this year, Luckin Coffee shocked the market by disclosing that nearly half the revenue it reported in the last three quarters of last year, or RMB2.2 billion, was fake.

The company blamed Chief Operating Officer Liu Jian for the misconduct and said it had initiated an investigation of Liu and four other employees. Investors sold 447 million Luckin shares on the open market in three days after the disclosure, equivalent to the total transactions over the previous 40 days. Trading was suspended in April, and in June the company was delisted.

Investors in Luckin Coffee could have known that there was too much froth and not enough coffee. A mysterious warning with inside information about fraud at the highest levels of Luckin Coffee had been sent to the inboxes of several short sellers.

Since Chinese regulators often punish those “spreading rumours” more harshly than they do the corporate fraudsters it was understandable that the whistleblower had decided to remain anonymous, even when the numbers provided in the extensive leak turned out to be conservative compared with the true nature of the fraud.

Western and Chinese investors alike just waved the leaked documents away as “fake news,” citing the anonymous nature as a clear sign that this was a disgruntled employee or a competitor.

Human nature being what it is, fraud will always occur if people think they can get away with it. If even Germans, famous for following the rules and being conservative with their savings, can produce a house of cards such as Wirecard, then perhaps China’s markets are just average. Still, during my few trips to Germany I have never once been told by a shopkeeper to invest in Wirecard.

File Photo: Wikicommons.

After reading the aforementioned book by the Bloomberg economist, I was persuaded that China’s technocrats in the past had been both lucky and smart in deflating various bubbles just before bursting point.

But while he plots out an interesting story with a grand narrative, it must be remembered that many smaller bubbles do pop. The rise and fall of Ofo and Luckin are examples of perverse incentives leading to outright fraud.

As long as the Chinese government does not provide legal protection for whistleblowers and frowns on independent investigative journalism, it will continue to be easier to commit fraud in China than in Germany, and there will be more Luckins than Wirecards.

Secondly, capital controls allow communist officials to set the RMB exchange rate and keep a firm hold on the big Party-controlled banks. Unfortunately capital controls prevent the flow of capital to where it is most profitable and most efficient. It forces domestic investors to get a lower rate of return on investment and creates bubbles at home, as China’s crazier busts have proven.

Finally, Chinese Party media should refrain from cheering on the stock market. In spring 2015, state media gave an extra push to the bull market and as a result, the crash was deeper than just a necessary market correction.

Reading exuberant reports about a stock market rally in state media today makes me fear that another financial crash is coming in China. As soon as someone at a market stand tells me to get into the stock market, it is actually time to get out. 

Please don’t take investment advice from tinkers or tailors. Remember that the second line of the nursery rhyme “Tinker tailor soldier sailor” is “Rich man, poor man, beggar man, thief.”


This piece was previously published in Dutch in the magazine Epoque, in a slightly revised version.

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Alexander Zwagerman

Alexander is a lecturer at the Arnhem Business School in the Netherlands and a fellow of the Sima Qian Foundation, advising governments and businesses about how the rise of China affects the global economy. With over ten years of work experience in China, he has written extensively about Chinese business and how free market solutions would solve many of China's problems. He has published books and articles in Dutch and English. On Press Freedom Day 2016 a Dutch collection of his essays was published by Pharos publishers and the proceeds were donated to HKFP.