China is a case study in how, apart from a handful of theoretical economists, no one really believes in a free market
Has anyone else ben tuning into the bemusing spectacle that is the Chinese stock market implosion?
It seems that the Chinese government has effectively nationalised its stock market. People thought shares were disconnected from reality before. Now that disconnect seems permanent.
And China will dodge some short term pain here, but only by throwing credibility and it’s dreams of becoming a first-world financial centre on top of the grenade.
And so it’s just not clear what all this means. It certainly makes you stop and wonder about the shape of the Asian Century. China will continue to dominate affairs in the region, just through sheer size, but China’s economy looks more and more like a derailed freight train.
Still moving, and a force to be reckoned with, but who knows where it’s going to end up.
Over the past year, the Chinese stock market has been a classic suckers game. The boom was on. Every man and their shoe-shine boy was piling everything they had into the stock market. And the government was more than happy to leave the money taps on to – to try and generate a bit of pop in the consumption numbers.
As a result, the Chinese stock market went stratospheric. Share prices tripled in just 12 months. At the peak, half the companies listed on the Shanghai and Shenzhen exchanges were priced above an indecent 85-times earnings!
The smart money started bailing out. As it always goes in these things, it’s the shoe-shine boys, the farmers and office clerks left holding the baby.
With the institutional investors heading for the exits, prices started to teeter. The Chinese government freaked, and the central bank tried to juice the market even further by cutting rates and relaxing bank reserve requirements.
(That’s right, just as the financial system was coming under attack, the government dropped reserves. Banks don’t need all of those safety measures. They just get in the way.)
Rate cuts had always worked in the past, but the run was on, and prices were still falling.
So the government got it’s own hands dirty. It rallied the major brokerages to form a $19 billion fund to buy shares and waded directly into the market, on a massive buying spree.
But that’s the thing about panic moves like this. Once the people saw the government in panic mode, they wondered what the government was scared of.
And so now it wasn’t just the institutional investors. The mums and dads were heading for the exits as well. Prices were heading south fast.
And when the tide goes out you get to see who’s swimming naked.
And the feedback loop came through margin lending. Chinese punters were borrowing in large amounts, from both brokerages and more shadowy sources — like “umbrella trusts” and peer-to-peer lending websites — to buy shares, with the shares themselves as collateral.
(According to Goldman Sachs, at the peak, formal margin lending alone accounted for 12%of the market float and 3.5% of China’s GDP, “easily the highest in the history of global equity markets.”)
Margin loans were a booster rocket on the way up, but a massive stone around the neck on the way down. As prices fell, borrowers started getting ‘margin calls’ that forced them to sell into a falling market, sending prices into free-fall.
Amazingly, Chinese regulators who had been trying to rein in margin lending did a full 180. They waved rules requiring brokerages to ask for more collateral when stock prices fell and allowed them to accept any kind of asset – including people’s homes – as collateral for stock-buying loans.
They also encouraged brokerages to securitize and sell their margin-lending portfolios to the public so that they could go out and make even more loans. All these steps knowingly exposed major financial institutions, and their customers, to much greater risk.
So in the face of a major market melt-down, the government is actively encouraging people to take on more risk!
But wait, that’s not all!
China launched a ‘war on stocks’ and took that war nuclear. They closed down the market and outlawed selling. About half of China’s 2,800 listed companies filed to suspend trading. Chinese regulators also banned major shareholders from selling any shares for the next six months. They then directed companies to start buying back their own shares and instructed state-run banks to provide whatever financing was needed.
Then in came China’s Ministry of Public Security – the thugs usually responsible for crushing political dissent. They announced that they would arrest what it called “malicious” short-sellers. But it was clear that this meant anyone whose selling (not just “short” selling) interfered with the government’s efforts to boost prices.
The market stopped dead in its tracks. Chinese brokers refused to accept sell orders for fear of angering the authorities.
Ultimately the government won. The stock market ‘stabilised’.
But it’s only a ‘market’ in a pretty loose sense of the word now.
It’s wild stuff.
And China’s commitment to ‘market forces’ has been show to be pretty weak.
Part of me thinks that this all puts China back 20 years. It’s like the saying goes, market forces are the worst possible way to allocate resources – apart from all the other options ever experimented with in human history.
The Chinese economy is huge, but it needs to get even bigger. It’s still very early days in China’s development. Chinese citizens are still a long way from enjoying first-world life styles.
But it gets harder and harder to centrally manage an economy at these proportions. It’s hard enough to know what your economy and people need, let alone navigate the rat swarms of vested interests to get those things done.
But let’s not get too holier-than-thou. Governments, banks, big business – everyone’s got their finger in the pie, in every country.
It’s just in China, no one’s pretending otherwise.
Where to for China from here? What does it mean for us?