China is in the midst of a triple bubble

The entire world is watching China's stock market collapse, but it's important to keep it within the context of the greater Chinese economy.

Thing is, the context is pretty bleak.

The way Credit Suisse sees it, the Chinese stock market is the least of the country's worries as shocking as it's slide has been.

The real problem is that all of this turmoil is happening in the midst of a "triple bubble."

"In our view, China is in the midst of a triple bubble, with the third biggest credit bubble of all time, the largest investment bubble (proxied by the investment share of GDP) and the second biggest real estate bubble," Credit Suisse analyst Andrew Garthwaite wrote in a recent note.

"This is occurring against a backdrop of near record producer price deflation, near record low growth in bank deposits (the main source of internal liquidity), FX outflows (the main source of external liquidity) and falling house prices (with property accounting for the majority of household wealth)."

Yes, China's stock market slide has been stunning. Until June 12th, the Shanghai Composite, mainland China's biggest stock market, had enjoyed a glorious 150% rally for about a year. Then everything turned and the indices death-dropped 30%. It's as if April, May and June never happened. All those gains have been erased.

What's more, it seems nothing the Chinese government is doing - not rate cuts, not IPO cancellations, not going after "malicious short sellers", not throwing almost $20 billion dollars at the market, not forbidding big investors from selling stocks for 6 months - can stop it.

But as many have pointed out the Chinese stock market is only a tiny part of the economy. It represents "less than 15% of household financial assets and equity issuance accounts for less than 5% of total social financing," wrote Qu Hongbin, HSBC's chief economist for Greater China.

That's why what Credit Suisse's Garthwaite points out is so important. If you're wondering why the Chinese government is freaking out about such a small part of their economy, it's because the rest of it needs restructuring.

The stock market was supposed to help out with that.

"The ideal situation would be several years of a steady bull market to cover the restructuring phase," Societe Generale's Yao Wei wrote in a recent note.

"Conversely, the worst-case scenario would be a stock-market crash before restructuring has even begun."

In other words, this stock market's collapse is forcing the government to hold off on implementing its "new normal" phase - a phase Xi promised would bring slower growth but more transparency and reform.

In the "new normal" the government was planning to restructure its entire corporate sector - especially property firms - and cut off easy money to the local government financing vehicles that were funding real estate projects like mad. There's a ton of debt in both sectors, and the banks are holding that debt.

And while things were starting to look up a tiny bit in the real estate market, analysts aren't calling an all-clear by any means yet.

"...there are some signs in Tier 1 and 2 cities that house prices are stabilizing," Garthwaite wrote. "To us the trends in housing are more important than the trends in the stock market. We remain fundamentally negative on housing because of the degree of overvaluation and overbuild, and doubt a rally in property prices can be maintained for long."

The government needed a safe place for Chinese people to put their savings to work. But the stock market turned out not to be that safe, and now the government may have to hold off on some painful reforms to keep confidence and consumption up and cash flowing through the economy.

Garthwaite writes that he wonders if this whole thing "represents a wider setback to the Third Plenum" - the government's master plan for China's economy.

Without the Third Plenum's planned reforms, the three real bubbles have more time to pop to China's detriment.

There's more. Garthwaite's colleague, Dong Tao, wrote in a separate note that the government probably doesn't have a choice in terms of whether or not to put its plans on the back burner either. Their number one concern is at stake here [emphasis ours].

"Besides the economic rationale behind making an outsized policy response, political considerations are equally important. China has one of the world's highest retail investor participation rates in the equity market. With the drastic fall in share prices recently, we think social stability is clearly at stake."

Maybe there's a fourth bubble.