Musings on China Market Mania
Given the absolute flurry of activity, I won’t even try and recap all the announcements and plans or breakdown the economics of them. I am just going to try and provide some perspective on the Chinese economy and financial markets.
- Unless the equity market fall is somehow converging into the black hole of debt China built up into an exploding supernova, I see little evidence of knock on financial risk. While the major Chinese indexes have fallen by about 30% in two weeks, they are all still up by 141% and 51% since June last year and the beginning of year respectively. This is the equivalent of winning the lottery and then declaring a financial crisis because the government wants its 30% in taxes. Taken in isolation and looking at the known and related data, I see little evidence that the falling stock market presents a financial risk worthy of the attention being paid it.
- In the absence of more conspiratorial theories as to the importance of the stock market fall, the most obvious risk is political. Many investors bought into the booking stock market because key Party mouthpieces kept talking it up. Though it is foolish for most anyone to stake their credibility to stock price movement, it is even more so for governments to do so and Beijing is facing a massive loss of confidence in their ability to move financial tides. Given the weak housing market throughout China excluding tier one cities, Chinese households are nervous about financial matters and looking to Beijing for answers. (Note: excluding tier one cities like Shenzhen, Shanghai, and Beijing which likely benefited from a wealth effect, the total housing market remains extremely weak). Beijing’s credibility has become attached to the stock markets and failure to at least arrest the collapsing stock prices will create a lot of angry investors who bought on the buy recommendation of Party appartchiks.
- The event that really set the tone for current economic and financial policy was about a month ago when the government, MOF, and the PBOC mandated a forced bailout of over indebted provincial governments after banks balked at buying underpriced long duration bonds. There are two specific reasons this is really defining moment in recent Chinese economic policy. First, despite all the fantastical and widely believed press releases about pricing risk and allowing defaults, the Chinese government clearly demonstrated the absolute lengths they would go to in preventing any problems. The bankers pushing back on buying enormously underpriced official debt were given their marching orders. There is no market in China and the quasi-market is one directional. Second, it implicitly revealed the rickety nature of official and government linked Chinese finances. If the banks who know the state of LGFV and provincial finances are refusing to buy public bonds, that should tell you everything you need to know. While there is no current indication that these two events have morphed into a Predator meets Aliens super-demon, the absolute flurry of meetings over the weekend does raise the possibility that Beijing is trying to patch problems much more profound than the stock market fall. However, until I see some hard evidence of this, I am going to believe they are worried about political risk of protesting pensioners.
- I have long been a critic of Chinese data. What concerns me about the current situation is that much of the hidden leverage or data discrepancies within the system could be coming out. Chinese banks have low NPL’s due to the extraordinarily liberal definition of NPL. Stock swaps that are essentially leverage and audited accounts that even the government auditor says contains discrepancies in the billions of dollars eventually cause significant problems. The problem with this type of data is that while you may suspect it, as is obviously the case here, as an outsider you never know what is going to turn a data discrepancy into a major issue. With firms pledging their own stock as collateral and banks accepting most any asset for repo transactions, I think the risk from unknown financial risks is quite high.
- Government intervention into financial markets, whether into propping up stocks or currencies, has a pretty dismal record. I am very skeptical the Chinese stock market will enjoy anything other than a dead cat bounce. The two key issues in any successful market intervention are size and credibility. On this count the reports about Chinese efforts are weak on both fronts. The reports currently are expected to have a 120 billion RMB ($20b USD) fund for stock market stabilization. This size, in the absence of additional capital, will do little more than provide a speed bump on the way down. While there are reports of significantly larger infusions, given the enormity of the capital market, discussions so far seem to underestimate the enormity of what Beijing is up against. Beijing’s credibility to stabilize the market, much less begin a rebound, is currently weak with many buyers seeing it as a good time to exit the market leaving Beijing to absorb the gambling losses. However, if Beijing did nothing more than absorb the losses and slow the market decline, that probably counts as a win in their book. Credibility is also important in that people have to believe the government will continue to engage and backup their policy. If people start selling to stop their losses or take their winnings off the table and Beijing doesn’t keep buying lending the policy credibility, this will destroy any hope of this market intervention succeeding. That will require however enormous market intervention. Given the nature of interventions that quickly revert to trend prior to intervention, I am deeply skeptical given the size and credibility concerns that this time will be different.
- The Chinese government has a profound misunderstanding of how markets work. During the global financial crisis, they executed a stimulus package equal to roughly 10% of GDP. Now they are putting forward a stock market stabilization fund that other than the press release is only slightly more than a rounding error on any given day in the Chinese stock market. This does however reveal their bias.
- Despite all the comparisons between market intervention by the US in the global financial crisis and China events, there are some enormously important similarities but also differences. First, all on the fly policy decisions are political in both countries. Second, fiscal stimulus was small in the US and large in China; market stabilization was large in the US and small in China. Third, in the US, the government bailed out the market; in China, the market is bailing out the government. Please note, especially investors in Chinese banks and brokerage houses: your money is being used to bail out excessively indebted governments and investors so Beijing can maintain credibility.
- I am betting that at best, the Beijing mandated fund will prompt a dead cat bounce or help the stock market tread water for a while before resuming its downward trend. Unless the psychological multiplier is enormous, after which Beijing’s credibility will be even more invested in stock prices, the stabilization fund seems merely to act as a buyer of last resort for people wanting to exit their positions. This means imposing enormous costs on public or quasi-public institutions. I doubt even Beijing can reinvigorate Chinese appetite for stocks.