China's economic growth coming in at 7 per cent in the June quarter was somewhat of a surprise.

Economists had been forecasting something closer to 6.8 per cent as industrial production had been grinding down for some time which, in turn, had been squeezing the brakes right across the world's second biggest economy.

Domestic demand looked to be stalling and the property boom has bust.

However, four rate cuts from the Peoples' Bank of China (PBoC) since late last year and the freeing up credit by easing banks' capital requirements helped land the GDP number right on the government's target.

The stock market collapse happened too late to be reflected in the June quarter figures yet, in many ways, it is a reminder that the number churned out by Government statisticians may not be an accurate reflection of what's actually going on.

Economy propped up by 'money created from thin air'

Research director at the Beijing-based J Capital Research Anne Stevenson-Yang said the collapse has exposed the potential overstatement of the Chinese economy and pointed to its reliance on debt.

"The stock market expansion is the most naked expression yet of the way in which Chinese authorities have created money in order to suspend in air the edifice of debt that is the economy, even as real spending, real production, total factor productivity, and the quality of life for Chinese citizens spiral into decline," Ms Stevenson-Yang wrote in a recent note to clients.

"The roughly 24 trillion yuan - $US3.8 trillion ($5.2 trillion) - added to the value of traded shares over the last year did not come from new value created by the companies, which have seen earnings decline, most of the money was created from thin air."

That creation of liquidity has seen funds funnelled from the PBoC, the Ministry of Finance and large commercial banks to the brokers and smaller, weaker financial institutions such as local banks and rural co-operatives.

Ms Stevenson-Yang said the government panic on display with the A-share market crash was primarily due to the threat of a major financial crisis, not collapsing share valuations.

"The emergency measures implemented throughout last week may forestall, but will not prevent it - in fact, they might speed its arrival," she warned.

Systemic risk to the economy

Credit Suisse's chief regional economist in China, Dong Tao, also noted that the sharp rise and fall of the equity markets now posed real systemic risks that could feed into the real economy.

The heart of the problem is the debt-fuelled binge that has blown up the Chinese equity bubble.

According to Credit Suisse estimates, securities companies now have 3.7 trillion Yuan - $US600 billion ($798 billion) - in margin positions outstanding, roughly four times higher than at the start of the year.

However, even this figure may be very conservative given the opaque and unregulated nature of over-the-counter margin lending.

"On top of the forced liquidation of umbrella trust funds, which has pushed the market toward a self-fulfilling downward spiral, we now fear a chain reaction," said Mr Tao.

Companies and investors have been mortgaging their shares to leverage up in the stock markets, while home-owners have been putting up their houses as collateral as well.

"It looks like further forced selling is on the way," Mr Tao warned.

"Worse, structured products were wide spreading, creating hidden risks that potentially could deliver unpleasant surprises."

There's little evidence of any orderly deleveraging going on.

A-shares likely to become 'one more dead asset'

Indeed Ms Stevenson-Yang has argued the government's dramatic intervention last week is producing higher levels of debt by encouraging brokers to extend margin loan maturities, while the PBoC is standing behind the China Securities Finance Corporation with unlimited liquidity.

"To maintain the fiction of high share values underpinning margin loans, a large fraction of shares have been suspended and new channels opened to help brokers shore up their battered equity positions," Ms Stevenson-Yang said.

"As a result, A-shares are likely to become one more dead asset with collateral value but no liquidity, just like property.

"As with functionally bankrupt developers, then, the emerging unpayable stock market debts will join the ever-swelling class of Chinese assets that float on the market like those bloated hog carcasses found drifting down the Yangtze some time ago when farmers apparently had not wanted to take responsibility for the diseased, and worthless, herd.

"But the suspended shares can only stay suspended forever if they are actually removed from the market, which could hardly be helpful for China's wish to be perceived as continuing reform toward 'letting markets decide' and hardly an inducement for new investment."

Currently about 40 per cent of stocks on the Shanghai market and almost 60 per cent on the Shenzhen exchange have been suspended from trading.

Apart from being suspended they share the common trait of being astronomically expensive.

The 111 industrial stocks suspended on the Shanghai exchange have an average price-to-earnings ratio (PE) of 187.

Those suspended in the materials sector have an average PE of 216 and the financials that have been halted are beyond nose-bleed territory, with an average PE of 700.

In other words, assuming these stocks traded again - and their share price didn't tank and they could maintain consistent earnings - shareholders would be waiting around 200, and up to 700, years to recoup their investments.

Ms Stevenson-Yang said that a consequence of the loss of confidence will not only be a flight of capital but, crucially, it will damage the government's credibility.

Suspended stocks on the Shanghai Composite Index

Sector Market cap (yuan, billions) Number of companies Average price-to-earnings ratio Industrials 1194 111 187 Consumer discretionary 1067 83 94 Information technology 702 41 160 Financials 667 47 700 Materials 593 71 216 Utilities 479 15 54 Health care 447 33 149 Consumer staples 270 35 204 Energy 176 10 159 Telco services 27 1 52

(As of July 9, 2015) Source: Bloomberg/J Capital Research

PBoC to adopt the 'whatever it takes' approach?

Credit Suisse's Dong Tao said China's central bankers may now have to follow in the footsteps of the US Federal Reserve in 2008 and the European Central Bank in 2012 with a "whatever it takes" policy.

The super-sized policy response may include anything from cutting interest rates by another percentage point or two and cutting commercial banks' reserve requirements even more, through to a complete ban of short selling and a massive program of share buying backed by the PBoC without the formalities of pre-setting a limit or timeframe for the action.

Not exactly the same blueprint as US and European quantitative easing programs, but the scale will need to be massive to ease the panic.

Mr Tao said, regardless of the next step the government takes, it and China's capital markets have suffered a major setback and a blow to their credibility.

'Asset bubbles critical to the appearance of growth'

As Anne Stevenson-Yang pointed out, a consequence could be less willingness on the part of Chinese companies and households to put their money in the latest government recommended asset class.

"Asset bubbles are critical to the appearance of growth, and China's ability to continue attracting external capital depends on being able to report superior growth," Ms Stevenson-Yang noted.

"Once the bubbles can no longer be maintained, the question of how big the Chinese market really is will be front and centre in the conference rooms of portfolio investors around the world."

Ms Stevenson-Yang said China's vaunted infrastructure projects may be viewed poorly in this light.

"The highly touted plans for One Belt One Road, the New Silk Road, the Asian Infrastructure Investment Bank, Mega Cities, and Chinese-sponsored pipelines and railroads criss-crossing every continent and tunnelling under every sea will seem less like ambitious plans to ascend the geopolitical power ladder and more like wild dreams of a face-seeking leadership with little but an empty toolkit and even emptier pockets," she concluded.