Credit Suisse thinks the stock market is the least of China's worries. Reuters 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.

And the context is pretty bleak.

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

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 12, 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.

The Shanghai Composite year-to-date. Yahoo Finance

What's more, it seems nothing the Chinese government is doing — not rate cuts, not initial-public-offering cancellations, not going after "malicious short sellers," not throwing almost $20 billion at the market, not forbidding big investors to sell stocks for six 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," Qu Hongbin, HSBC's chief economist for greater China, wrote.

China's producer price inflation index. Barclays That's why Garthwaite's point is so important. If you're wondering why the Chinese government is freaking out about such a small part of the country's 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 President Xi Jinping promised would bring slower growth but more transparency and reform.

Chinese President Xi Jinping. REUTERS/Saul Loeb/Pool 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."

Credit Suisse

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 whether 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.

Xi speaking in front of an electronic board showing stock information at a brokerage house in Huaibei, Anhui province, in 2012. Reuters And there's more. Garthwaite's colleague, Dong Tao, wrote in a separate note that the government probably didn't have a choice of whether to put its plans on the back burner. Its top 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.