China's attempt to buck the market ....... is it achievable, or even desirable ?

Tuesday 28th July

 

China's attempt to buck the market ....... is it achievable, or even desirable ?

 "Crash poses serious threat to Beijing's credibility" , The Financial Times, p.6

The Shanghai Composite Index fell another 1.7% today after yesterday's 8.5% fall that was the second largest in its history. The easiest conclusion to draw would be that the extraordinary measures put in place by the Chinese authorities to boost prices in early July after the market had fallen by more than 30% have failed, at least up to now. The measures included :

     A ban on short-selling

    A suspension of IPO's

    Forced purchases of shares by state-owned investors

    A ban on share sales by leading investors

    Direct support from the central bank

No doubt the attempt to support the market was welcomed the wave of new, highly-leveraged individual investors who on the way up must have thought that buying shares was a one-way bet. The trouble is that shares are suspended in China after a 10% move and many are still holding stock that they desperately need to sell to pay margin calls. Global investors who are used to the boom/bust gyrations of free markets take a different view, even if Beijing does manage to staunch the bleeding.

 The fact is that on any longer-term basis attempts to defend artificial levels imposed by authorities are generally doomed to fail. If the fundamentals demand it, markets will test the resolve of those doing the defending until the momentum is such that the dam has to break (think currency markets, ERM etc.). China has enormous amounts of ammunition that it can bring to the fight, but ultimately the fundamentals will win out. At least, that's the case in FREE markets.....

The perception is that the authorities artificially fuelled the boom in stock markets (more than doubling in 12 months) by allowing inexperienced new investors to run highly-leveraged accounts. The aim was to allow highly indebted state-controlled corporates to swap expensive debt for cheaper equity, and if domestic consumer demand was also boosted by profits gained by investors .... well, that's all good too. The trouble is that it requires a continuing bull market and represents a particularly one-eyed view of how markets operate. And importantly, the Beijing's actions both on the way up and the way down do NOT have a place in the ground rules for a free market.

China wants to be a big player on the global financial stage, but none of the big institutions is likely to commit fully to China until Beijing shows a willingness to refrain from intervention (manipulation?) and let the markets take their course, good or bad. At the same time, China's desire for the yuan to take its place as an International Reserve Currency will have suffered a considerable set-back.

One last thing..... The problem with this kind of intervention is once you start, how do you stop without allowing the market to crash ? And once you stop, how do you get out of the positions that you've accrued during the course of the operation ? The suggested trigger for yesterday's slump ranged from an impending US rate rise to a jump in local pork prices. Perhaps most interesting was the suggestion that the authorities had made the first enquiry about unloading some stock  --  this was of course vehemently denied. Whatever the case, China's problems are not down to a rise in the price of piglets.