Many Chinese people have taken to investing on the Chinese stock market, seeing it as a way of making a lot of money quickly. From October 2014 to June this year the market soared, rising by 126% from 2290 to 5166.
More and more people used their savings to buy stocks and China now has over 90 million individual investors. And it was not just savings that were invested. Increasingly people have been borrowing money to invest, seeing it as an easy way of making money. Unlike stock markets in developed countries, where the majority of shares are held by financial organisations, such as pension funds, holdings by individuals account for about 80% of stocks on the Chinese market.
But since mid-June, share prices have plummeted by 32% (see chart). People have thus seen a huge fall in the value of their savings, while many others have found their shareholdings worth less than their debts. The fall, like the rise that preceded it, has been driven by speculation, fuelled by first optimism and then pessimism.
The Chinese government is worried that the fall might dampen investment and economic growth. It has thus has been supplying liquidity to various institutions to buy shares, but this has had little effect and is dismissed by many as meddling. What is more it could expose companies which take advantage of the liquidity to greater risk.
So serious has been the rout, that over 50% of listed companies have halted trading on the mainland Chinese stock exchanges.
So just why has there been this bubble and why has it burst? What implications will it have for (a) China and (b) the rest of the world? The following articles explore the issues.
China’s stock market fall hits small investors BBC News Magazine, John Sudworth (7/7/15)
China Stocks Plunge as State Support Fails to Revive Confidence Bloomberg (8/7/15)
Chinese stocks are crashing Business Insider UK, Myles Udland, David Scutt (8/7/15)
Shanghai stocks plunge, over 1,200 Chinese companies halt trading Economic Times of India (8/7/15)
Everyone freaking out about China’s stock-market crash is missing one thing Business Insider UK, Elena Holodny (7/7/15)
China’s stock market has lost nearly a third of its value in a month Vox, Timothy B. Lee (8/7/15)
Chinese leaders may be undermined as investors suffer stock market slide The Guardian, Emma Graham-Harrison (8/7/15)
Opinion: China’s stock-market crash is just beginning MarketWatch, Howard Gold (8/7/15)
What does China’s stock market crash tell us? BBC News (22/7/15)
Questions
- What is meant by a ‘bubble’? Has the recent performance of the Shanghai Stock Market been an example of a bubble?
- Is the current fall in share prices in China an example of overshooting? Explain how you would decide.
- Distinguish between stabilising and destabilising speculation. Why does destabilising speculation not go on for ever?
- What is meant by the ‘stock market wealth effect’? How is the fall in the Chinese stock market likely to affect consumption and investment in China? How does the proportion of assets held in the form of shares affect the magnitude of the effect?
- What are the likely implications of the fall in the Chinese stock market for the rest of the world?
- Why has the Hong Kong stock market not behaved in the same way as the Shanghai market?
- What have the Chinese authorities been doing to arrest the fall in share prices? How likely are they to succeed?
Last week saw the launch of Apple’s new music streaming service. This will clearly provide serious competition for the existing music streaming providers such as Spotify and Tidal. One important difference is that whilst Spotify offers a free version to listeners funded by advertising revenue, all Apple Music users will be required to pay a monthly subscription charge. However, Apple will allow listeners a free three-month trial of its service.
Initially Apple intended not to pay artists royalties during this trial period. However, it soon reversed this plan when the pop-star Taylor Swift wrote a blog post criticising Apple for this and threatening to withhold her most recent album.
The negotiations between Apple and the record labels are also facing considerable scrutiny from the competition authorities on both sides of the Atlantic. They seem particularly concerned that Apple may have conspired with or pressured labels to withdraw their support for rival streaming services such as Spotify that offer free versions to consumers. Although not clear, it has been suggested that the European Commission’s initial probe into this may have been initiated by a complaint from a company offering such a free version of its service.
On the other hand, there has also been considerable criticism of free music services such as Spotify. One of the cofounders of the Beats music streaming service, which was subsequently acquired by Apple, has argued that the free business model does not properly value recorded music. Likewise, Taylor Swift removed her entire back catalogue from Spotify, and the leading record label, Universal, is applying pressure on Spotify to change its business model. It is currently unclear whether Apple has been directly responsible for Universal’s standpoint. What is clear is that Apple’s entry will shake-up this market and the identity and business model of the future market leader is at stake.
Streaming sets off a painful debate in the music industry Financial Times, Jonathan Ford (22/03/15)
Apple’s new music service will push paid subscriptions, with free samples re/code, Dawn Chmielewski and Peter Kafka (08/05/15)
Taylor Swift is fighting the wrong part of the music industry Financial Times, Jonathan Ford (05/07/15)
Here’s what happens to your $10 after you pay for a month of Apple music re/code, Peter Kafka (15/06/15)
Questions
- What are the key features of the music streaming service market?
- What are the pros and cons of Spotify’s business model?
- Why might the views on free streaming services differ between small and large artists and labels?
- How do you think the music streaming market might develop in the future?
It was argued in an earlier blog on the Greek debt crisis that a deus ex machina was needed to find a resolution to the impasse between Greece and its creditors. The most likely candidate for such as role was the IMF.
Three days before the Greek referendum on whether or not to accept the Troika’s proposals, the IMF has stepped onto the stage. To the undoubted surprise of the other two partners in the Troika (the European Commission and the ECB), the IMF argues that Greece’s debts are unsustainable and that much more is needed than a mere bailout (which simply rolls over the debt).
According to the IMF, Greece needs €52bn of extra funds between October 2015 and December 2018, large-scale debt relief, a 20-year grace period before making any debt repayments and then 
debt repayments spread over the following 20 years. In return, Greece should commit to supply-side reforms to cut out waste, reduce bureaucracy, improve tax collection methods and generally improve the efficiency of the economic system.
It would also have to agree to the previously proposed primary budget surplus (i.e. the budget surplus excluding debt repayments) of 1 per cent of GDP this year, rising to 3.5 per cent in 2018.
So it this what commentators have been waiting for? What will be the reaction of the Greeks and the other two partners in the Troika? We shall see.
Articles
IMF says Greece needs extra €50bn in funds and debt relief The Guardian. Phillip Inman, Larry Elliott and Alberto Nardelli (2/7/15)
IMF: 3rd Greek bailout would cost €52bn. Or more? Financial Times, Peter Spiegel (2/7/15)
IMF: Greece needs to reform for sustainable debt, financing needs rising CNBC, Everett Rosenfeld (2/7/15)
The IMF has made an obvious point about Greece’s huge debt. Here’s why it still matters Quartz, Jason Karaian (3/7/15)
Greece: when is it time to forgive debt? The Conversation, Jagjit Chadha (2/7/15)
IMF Analysis
Greece: Preliminary Draft Debt Sustainability Analysis IMF (2/7/15)
Preliminary Debt Sustainability Analysis for Greece IMF (25/6/15)
Questions
- To which organisations is Greece indebted? What form to the debts take?
- To what extent is Greece’s current debt burden the result of design faults of the euro?
- What are the proposals of the IMF? What effect will they have on the Greek economy if accepted?
- How would the IMF proposals affect aggregate demand (a) directly; (b) compared with the proposals previously on the table that Greece rejected on 26 June?
- What would be the effects of Greek exit from the euro (a) for Greece; (b) for other eurozone countries?
- What bargaining chips can Greece deploy in the negotiations?
- Explain what is meant by ‘moral hazard’. Where in possible outcomes to the negotiations may there be moral hazard?
- What has been the impact of Greek austerity measures on the distribution of income and wealth in Greece?
- What are the practicalities of pursuing supply-side policies in Greece without further dampening aggregate demand?
The negotiations between Greece and the ‘troika’ of creditors (the IMF, the European Commission and the ECB) have seen many twists and turns before breaking down on 26 June. Throughout, both sides have sought to give as little as possible while seeking a compromise. Both sides have claimed that their position is reasonable, even though a gulf has remained between them.
What has been playing out is a high-stakes game, where the optimum outcome for each side is quite different.
Greece seeks bailout terms that would allow it to achieve a smaller primary budget surplus (but still a surplus in the midst of a deep recession). The surplus would be achieved largely through tax rises on the wealthy rather than further cuts that would hit the poor hard. It is also seeking a substantial amount of debt forgiveness to make servicing the remaining debt possible.
The troika is seeking a larger budget surplus than the Greeks are willing to contemplate. This, it maintains, should be achieved largely through additional cuts in government expenditure, including further reductions in pensions and in public-sector wages.
Both sides used threats and promises as the negotiations became more and more acrimonious.
The troika threatened to withhold the final €7.2bn of the bailout necessary to pay the €1.6bn due to the IMF on 30 June, unless the Greeks accepted the terms of the austerity package put to them. The Greek Prime Minister, Alexis Tsipras, in rejecting the proposals, called a referendum on the package. This threatens the stability of the eurozone as a No vote, if it led to a Greek exit from the eurozone, could undermine confidence in monetary union. After all, if Greece could be forced out, other countries facing severe difficulties might also be forced out at some point in the future. Once a country leaves the eurozone, the monetary union becomes more like a system of pegged exchange rates. And pegged exchange rates are open to destabilising speculation at times of economic divergence.
A Greek exit from the euro (dubbed ‘Grexit’) is seen as undesirable by most Greeks and by most politicians in the rest of Europe. The optimum for both sides collectively would be a compromise, which saw more modest cuts by Greece and the eurozone remaining intact. By both sides seeking to maximise their own position, the Nash equilibrium is certainly not the best outcome.
But as long as the troika believes that the Greeks are likely to vote Yes to the proposed bailout terms, it still hopes to get the outcome that is best from its point of view – an outcome that would probably involve regime change. And as long as the Greek government hopes that a No vote will force the troika to think again and come back with less austere proposals, it still hopes to get the outcome that is best from its point of view. But the outcome of this game of ‘chicken’ could well be Grexit and a Nash equilibrium that neither side wants.
But while the endgame is being played out by politicians, people in Greece are suffering. Policies of severely depressing aggregate demand to turn a large budget deficit into a primary budget surplus have led to the economy shrinking by 26%, overall unemployment of 27% and youth unemployment of over 60%. The Greeks truly believe themselves to be stuck between a rock and a hard place.
The following articles look at the nature of the ‘game’ being played and at the effects on the Greek economy, both of the proposed austerity package proposed by the troika and Grexit. They also look at the knock-on effects for the eurozone, the EU and the global economy.
Can game theory explain the Greek debt crisis? BBC News Magazine, Marcus Miller (26/6/15)
Against the Grain: What Yanis Varoufakis can learn from a real game theory master – Nicola Sturgeon City A.M., Paul Ormerod (24/6/15)
John Nash’s Game Theory and Greece Bloomberg, Mohamed A. El-Erian (29/5/15)
The Greek crisis: that 1931 moment The Economist, Buttonwood column (23/6/15)
How game theory explains Grexit and may also predict Greek poll outcome The Conversation, Partha Gangopadhyay (1/7/15)
Greece debt crisis: Tsipras may resign if Greeks vote yes BBC News (30/6/15)
Greek debt crisis: Is Grexit inevitable? BBC News. Paul Kirby (29/6/15)
Existential threat to euro from Greek exit BBC News, Robert Peston (29/6/15)
How I would vote in the Greek referendum The Guardian, Joseph Stiglitz (29/6/15)
Greece in chaos: will Syriza’s last desperate gamble pay off? The Guardian, Paul Mason (29/6/15)
What happens if Greece defaults on its International Monetary Fund loans? The Telegraph, Mehreen Khan (30/6/15)
For Greece’s international creditors, regime change is the ultimate goal The Telegraph, Jeremy Warner (29/6/15)
Europe has suffered a reputational catastrophe in Greece The Telegraph, Ambrose Evans-Pritchard (2/7/15)
Questions
- What is meant by a primary budget surplus?
- What was the troika’s proposal on the table on the 26 June that was rejected by the Greek government?
- What was the Greek government’s proposal that was rejected by the troika?
- Explain the decision trees outlined in the first BBC article below.
- In terms of game theory, what form of game is being played?
- Are the negotiations between the Greek government and the troika a prisoners’ dilemma game? Explain why or why not.
- Does the game being played between the SNP and the Conservative government in the UK offer any useful lessons to both sides in the negotiations over Greece’s possible bailout and its terms?
- Does a No vote in the referendum on 5 July imply that Greece must leave the euro? Explain.
- What would be the effects of further austerity measures on aggregate demand? What benefits to the Greek economy could be achieved from such measures?
- Why may pegged exchange rates be regarded as the worst of both worlds – a single currency in a monetary union and floating exchange rates?
Deloitte recently published its 24th Annual Review of Football Finance and it contained some surprising results. Historically, most teams in the English Premier League (EPL) have made accounting losses with any increases in revenues being offset by higher wage costs. However, this report found that in 2013–14 most teams in the EPL actually made accounting profits.
The Deloitte’s review reported that the combined operating profits of clubs in the EPL increased from £82 million in 2012–13 to £614 million on 2013–14 – an enormous increase of 649%. Nearly all of the teams (19 out of 20) in the league made an operating profit while 14 also reported pre-tax profits. Dan Jones, head of Deloitte’s Sports Business Group, commented that:
“The change in club profitability in 2013–14 was more profound than anything we could have forecast.”
Why has the profitability of teams in the EPL suddenly improved so dramatically? One important factor was the significant increase in revenue. The combined income of the teams was £3.26 billion in 2013–14 – an increase of £735 million, or 29% on the previous year. Although match-day and commercial revenue both increased, the majority of this growth in income (nearly 80%) came from the sale of broadcast rights. The 2013–14 season was the first year of a new three-year contract that raised over £1.7 billion per year from the sale of these rights in both the UK and overseas.
However, clubs in the EPL have received big increases in revenue from TV deals before and still made substantial accounting losses. For example, the broadcasting contract that ran from 2010–13 generated over £1.1 billion per season – a £243 million per annum increase on the previous deal. Significantly, in the first year of this deal (2010–11), 81% of this increase in revenue went straight into higher player salaries, whereas in 2013–14 this figure was only 16%. The ratio of wages to turnover also fell from 71% in 2012–13 to 58% in 2013–14
So why did a smaller proportion of the increase in revenue go to the players compared with previous years? The explanation appears to be the impact of two new controls and regulations that were implemented by the EPL at the beginning of the 2013–14 season.
One of these has received considerable media attention and is similar to UEFA’s Financial Fair Play regulations. The Profitability and Sustainability Rules allow the clubs to make a maximum cumulative loss of £105 million over three seasons before having to face sanctions from the league. The size of the permissible loss is significantly higher than in the UEFA regulations.
The other control that has received far less attention is called Short-Term Cost Control (STCC). This regulation places limits on the extent to which clubs can increase their total wage bill. It operates from 2013–14 to 2015&ndash16: i.e. it covers the same three years as the current TV deal. For the 2013–14 season it worked in the following way.
If teams had a wage bill of less than £52 million they faced no restrictions on their spending on players’ salaries. Only Crystal Palace (£46 million) and Hull City (£43 million) fell into this category. Unsurprisingly, the five biggest spending clubs, Man Utd, Man City, Chelsea, Arsenal and Liverpool, had much greater wage bills of £215m, £205m, £192m, £166m and £144m respectively.
Any of the 18 teams that exceeded the £52m limit would still not face sanctions if their wage bill increased by £4 million or less. For example, Stoke City’s wage bill only increased from £60m to £61m, while Tottenham Hotspur’s increased from £96m to £100m. Some clubs actually managed to reduce their total wage bill, including the champions, Manchester City, which managed to lower its from £233m to £215m.
However, there were still 12 teams with a total wage bill that was greater than £52 million in 2013–14 and which had increased by more than £4 million on the previous year. For these teams not to face any sanctions, they had to prove to the EPL that any of the increase above £4 million was either due to player contracts entered into before January 2013 or could by financed from the following two sources.
• Club Own Revenue Uplift
• Profit from player transfers
Whereas the profit from player transfers is straightforward, the ‘Club Own Revenue Uplift’ requires some explanation, as it excludes a very important part of teams’ incomes – Central Fund payments.
Some revenues earned by clubs in the EPL are referred to as ‘Central Fund payments’. These are, in effect, income payments from money that is raised centrally by the EPL on behalf of the clubs and then distributed to the teams using an agreed formula. The majority of the revenue generated under this category is from the broadcast deals, although some commercial income, such as the sponsorship of the league, also falls under this category. For some teams the money raised from Central Fund payments makes up the majority of their revenue.
‘Club Own Revenue’ in STCC calculations refers to all revenues other than those from Central Fund payments. This includes a number of income streams that the club has more direct control over. They include:
• Gate money/other match-day revenue
• Commercial deals negotiated by the individual club
• Income from playing in European competitions, including TV revenue.
The uplift refers to increases in revenue from these sources compared to 2012–13.
For example, assume a club has made no profit from its transfer dealing and did not enter into any significant player contracts prior to January 2013. If this club’s wage bill increased from £100m in 2012–13 to £110m in 2013–14 then it would have to provide evidence to show that £6m of this increase could be financed from growth in its Club Own Revenue. In other words, it would have to demonstrate how its income from gate money, commercial deals and playing in Europe was at least £6m higher in 2013–14 than it had been in 2012–13.
It will be interesting to see if (1) the profitability of the clubs continues to improve in future years and (2) the STCC regulations are extended when the new broadcast deal comes into effect in 2016–17.
The EPL Proves Cost Control Works The Judge 13 (4/6/15)
English Premier League clubs made more revenue than Spain and Italy’s clubs combined UK Business Insider, Lianna Brinded (4/6/15)
Premier League football club revenues and profits soar BBC News, Bill Wilson (4/6/15)
Deloitte Premier League list: Clubs’ revenue boom to £3.3billion as Tottenham record highest ever pre-tax profits after Gareth Bale transfer The Independent, Joanna Bourke (4/6/15)
Annual Review of Football Finance 2015 Premier League clubs generate over £3bn revenue in season of records Deloitte (4/6/15)
Premier League top of the rich list with record income of £3.26bn The Guardian, David Conn (4/6/15)
Questions
- What is the difference between an operating profit and a pre-tax profit?
- If a club reports that it is making an accounting profit, does this mean that it must be making an economic profit? Explain your answer.
- Give some examples of the economic costs of running a football club that might not be included in accounting calculations of profit.
- How is the profit/loss from player transfers calculated?
- Explain why the current rules may give teams that play in European competitions a competitive advantage.
Many Chinese people have taken to investing on the Chinese stock market, seeing it as a way of making a lot of money quickly. From October 2014 to June this year the market soared, rising by 126% from 2290 to 5166.
