China’s clumsy attempts at salvaging its stock market are causing serious damage. And it’s not over
Zoology applied to finance and economics is all about big animals. Depending on whether you’re optimistic about the general state of affairs, you’re either a bull or a bear. Asia’s economic champions are tigers; Africa’s are lions. Even the snake manages to find its role in finance textbooks, as a metaphor of the relationship between corporate bonds and company earnings.
But the biggest beasts are reserved for nations at the top of the food chain. And these days it’s all about China. Of course the panda’s been out there for some time, for obvious reasons. But in recent days the elephant – of the Asian kind – has also been let out of its cage. And that’s not good news: it is threatening to break something with every move it makes.
Most vulnerable is the country’s stock market. Shares on the Shanghai bourse fell by more than 40 percent last summer after the Chinese central bank let the yuan depreciate, a move investors interpreted as a government-driven attempt to boost the country’s exports. That implied that the Chinese economy was doing worse than they thought, which given its weight didn’t bode well for the rest of the world.
The People’s Bank of China has since argued that it wanted to give freer rein to the yuan, a precondition to it being included in the IMF’s reference basket and becoming a currency other central banks hold in reserve. But it then spent $300bn of its own dollar reserves to try and stabilise the currency.
Meanwhile the China Securities Regulatory Commission, which regulates the stock exchange, went to extreme lengths to push shares back up. It suspended IPOs, froze trading on hundreds of listed stocks and banned share sales by large shareholders. It even formed a ‘national team’, comprising a raft of state-backed banks and companies, tasked with buying shares en masse. The motley squad owned at least 6 percent of the market last November.
All this eventually stabilised the market, which over the last quarter held relatively steady. But it took a while for it to work, leading many to wonder whether the authorities had real power to prevent a crash. And it raised serious doubts about whether the market rally was sustainable.
On January 4 it became obvious that it wasn’t. Investors indeed took fright at the planned withdrawal of support measures, due to expire later in the week, and shares dropped 7 percent on what was the year’s first day of trading (their worst beginning ever).
CSRC thought it had this covered: to prevent “market panic”, it had put together a ‘circuit breaker’, a mechanism that halts trading whenever share prices fall below a certain threshold. The problem, as the system's inventor himself told Bloomberg on Friday, is that China’s circuit breaker was especially poorly calibrated.
Designed to suspend trading for 15 minutes after a 5 percent dive, and for the entire day after a 7 percent plunge, it sent traders back home after only 29 minutes on Monday. And again on Thursday. A 7 percent drop, by comparison, only prompts a pause of 15 minutes on the New York stock exchange, a much less volatile market than China’s.
Instead of preventing panic, the system thus appears to have accelerated it, as traders rushed to offload shares before being blocked from selling. And so yesterday – four days after it went into effect – officials suspended the rule.
No matter how embarrassing the episode is, few dispute that was the right thing to do. But plenty of other restrictions, due to expire, have instead been made permanent. CSRC has imposed a 10 percent limit on single stock moves; it also prevents investors from buying and selling the same shares in a day. And it has set a new limit on how much of a stock large shareholders can divest. All this, in effect, continues to tell investors that they’re welcome to buy, but not sell. It’s probably the best way to freak them out.
Some say the performance of China’s stock exchange doesn’t really matter: companies raise little funding from the market and individuals don’t stash much of their savings in it. But some of the most dynamic sectors of the Chinese economy, such as IT, clean technology and media, are much more reliant on it. And jitters on the Shanghai stock exchange send signals to the rest of the globe, with the sobering effect on world markets we saw this week.
It’s not that the performance of Chinese stocks tells much about the performance of the real economy: growth was already slowing in the first quarter of last year, while shares were trading at lofty prices. Investors know this. But the current debacle reveals the extent to which Chinese policymakers, in their attempts to stem the crisis, are improvising – and improvising badly.