China stocks: turning a crisis into a catastrophe

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The government has allowed what should have been a simple market correction to get the better of it.

China stocks-R-600


Did China really need another casino? The country already boasts one of the world’s largest gaming meccas in the form of Macau, the pint-sized former Portuguese colony on the country’s heaving, bustling southern shores.

Over the past year, however, perhaps deciding that one was not enough, Beijing opted to turn its onshore stock markets into a de facto gambler’s paradise.

Rules that once forbade investors from borrowing on margin to buy onshore-listed A shares were lifted. Formal brokers and shadow lenders of all stripes moved swiftly to disburse cash to the callow day traders – housewives, miners, white-collar office workers – that comprise the bulk of the country’s investor base.

Even China’s political leaders got in on the act. With foreign direct investment waning and property prices slumping, Beijing needed to find new ways to fuel its capital-hungry economy.

If the country’s former leader Deng Xiaoping once shocked hardliners by declaring that to get rich was "glorious", now the mantra was refined to cater to the country’s aspiring capital markets. Up (literally) went the state-sanctioned cry in universities around the land: "Revive the A shares! Benefit the people!"

Beijing’s reaction to these wild gyrations was somehow both predictable yet unexpectedly disproportionate

The result was inevitable. Prices in securities listed on the main bourses in Shenzhen and Shanghai went haywire. The value of shares traded on the Shanghai Composite index doubled between November and June, with the value of some newly listed shares rising 4,000%.

Then the bubble burst, as they always do. Between mid-June and July 8, the Shanghai Composite fell 32%. More than 1,400 shares were suspended.

Beijing’s reaction to these wild gyrations was somehow both predictable yet unexpectedly disproportionate.

This was hardly the country’s first stock boom, neither its first slump. Valuations rose sharply in 1992, 1993 and 2001 before falling back; in 2007 the Shanghai Composite more than tripled in value in just 12 months – then pared back all its gains.

Each time the government acted swiftly, prohibiting initial public offerings and freezing the market in its tracks.

This time was different. Again, Beijing slapped a ban on all planned and ongoing IPOs. But it also broke with tradition by moving to support valuations, rather than letting stocks find their own, natural levels.

The intervention then took on a more heavy-handed tone. Beijing told state-run firms and brokers to buy and hold stock. On July 9, police visited the country’s securities regulator, the CSRC, to investigate "stock manipulation".

Insidious interference

Tame media outlets muttered darkly about insidious interference by foreigners and short-sellers. Regulators pushed brokers to buy shares to underpin the market.

When that didn’t work, fears grew that the government reached into its armoury for another bazooka – after giving the green-light for retail investors to use their property as collateral for margin loans – when authorities flirted with deploying their state-run margin trader with Rmb3 trillion in reserves mid-July.

China Securities Finance, created in 2011 to channel funding to the margin-trading divisions of mainland brokers, was reportedly ordered to dip into the fund to buy stocks, offer liquidity to brokerages, and support the wavering market, before authorities backtracked, in a rare concession to fears over moral hazard.

After their rise to power in 2012, Chinese president Xi Jinping and his premier Li Keqiang spoke often and publicly about the importance of reforming China’s sclerotic state enterprises, and its backward financial system.

They also vested much of their political capital into the past year’s stock market boom. It was seen by Beijing as a quick way to boost individual wealth, channel capital into the maw of young firms, and help larger firms trim their debts, just as a 25-year economic boom was showing signs of entering its final stages.

So when stocks stopped rising and started falling, Xi and Li were presented with their own version of Sophie’s choice. Allowing valuations to settle naturally would boost their reformist credentials, while forcing onshore investors to begin to see equities as a long-term investment tool, rather than a get-rich-quick scheme.

However, having so tacitly talked the market up, retail investors fully expected the state to intervene as it bumped its way down. To not act would be to appear enfeebled and emasculated, and could have led to social unrest, something that China’s leaders ultimately could not countenance.

Inevitably, they plumped for the no-win latter option.

While the Shanghai Composite bounced back, the cost of Beijing’s muscular interventions should not be underestimated.

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By intervening so heavily, they undermined their own reformist credentials. By refusing to bow to the invisible hand of the capital markets, they signalled their distaste for any type of capital-forming propellant they could not fully control. 

And by acting randomly and impulsively to quell market volatility, they began to exude a whiff of the scent that no government, let alone one as controlling as Beijing’s, likes to emit: panic.

What should have been a simple and reasonably stress-free market correction has become a nightmare for a government terrified of chaos and turmoil. It casts doubt on the current leadership’s ability to act sensibly and rationally in the event of a genuine, future financial or economic crisis.

And for the wider world, from institutional investors to political leaders to commercial lenders, it paints a picture of a government not entirely confident in its own decision-making, let alone its ability to control something as inchoate and arbitrary – and as wonderfully free-wheeling and meritocratic – as a stock market.

Bets on when China will allow full capital-account liberalization – making the RMB a truly convertible global reserve currency – are now off.