The Chinese government has imposed its will on the Shanghai and Shenzhen stock “markets” as both have stabilized since their precipitous late June and early July falls. This stops the bleeding and neutralizes the fear that the market is going to get beaten down like a Chinese lawyer. However, this presents a whole new set of challenges for Beijing and further restricts its policy options.
Skinner: The Lizards are a godsend.
Lisa: But isn’t that a bit short sighted? What happens when we’re overrun by lizards?
Skinner: No problem. We simply unleash wave after wave of Chinese needle snakes. They’ll wipe out the lizards.
Lisa: But aren’t snakes even worse?
Skinner: Yes, but we are prepared for that. We’ve lined up a fabulous type of gorilla that thrives on snake meat.
Lisa: But then we’re stuck with gorillas!
Skinner: No, that’s the beautiful part. When wintertime rolls around, the gorillas simply freeze to death.
Beijing is enacting a Simpsonian financial policy to contain the stock market fall. While public purchases stabilize the prices, it creates a potentially even bigger set of problems later and I won’t even address the most obvious moral hazard.
First, given the near complete policy against selling stocks for brokers, insiders, key stakeholders, asset managers, and others which comprise a large portion of recent buying, how can these firms sell without pushing the market down? This policy is essentially locking up a large amount of stock market and financial liquidity which does push the price higher, but also creates the problem of what happens when firms want or need to sell. Market volatility in China and the relatively low level of free float implies that large institutional sellers exert enormous downward price pressure. While the price problem has been stopped in the short term, it has created the problem of unraveling this buying spree by an institution that moved the market.
Second, given the rapid rise in associated debt with the stock market, especially with firms that became dependent on the stock market for profit growth, what happens to this debt given the near criminal prohibition on selling? Given the near perfect correlation between margin debt and the stock market, the debt can only be reduced by selling stock to pay of the debt. However, selling puts downward pressure on the price. Additionally, the interest rates on margin loans are relatively high by some accounts approximately 20 percent for retail investors though likely significantly lower for large companies and SOE’s. Unless Beijing opts to simply freeze debt and roll it over indefinitely, to avoid having to sell stock pushing the market down which it has done to some degree, that debt is going to remain in a state of suspended animation.
Third, given the policy freeze on sell side liquidity and the encouragement to tie up bank and financial liquidity it stock based lending, how can liquidity be increased without prompting a decline in multiple asset classes? The entire China economic growth story is built on selective liquidity restrictions to achieve political objectives. Banks are built upon restricting lending to small and medium size enterprise for the benefit of large SOE’s. A large percentage of the stock market is essentially frozen for fear of collateral calls on debt and jail terms. Encouraging banks to pump liquidity into the stock market via various loan mechanisms to buy stocks they cannot sell, already an incredibly risky gambit, saps liquidity from the provincial bond market bailout which is supposed to increased to an eye catching RMB 3.6 trillion. As all current liquidity is coming from the government and government mandates, loosening liquidity requirements run the very real risk of challenging many markets.
Fourth, as the public buying is an attempt to restore market confidence and bring investors back, what happens if hoped for non-public euphoric buying fails to materialize? Capital is flowing out of China at an unprecedented rate and foreign investors want nothing to do with the Beijing sponsored casino. Capital is flowing out of China at an unprecedented rate and foreign investors want nothing to do with the Beijing sponsored casino. This will require enormous public capital to even sustain the market lacking large inflows of private capital much less push it to pre-fall highs. It is questionable whether even Beijing has the willingness to act as the buyer of last resort at specified prices in the stock market. While Beijing has arrested the decline in the stock market, there is little evidence Beijing has thought through how to extricate itself from this morass.
The China Securities Finance Corporation (CSF) with the eye catching RMB 3 trillion purchasing facility will likely stabilize the market, but then what? There is no evidence that firms or individuals unrelated to the Chinese government are piling back into the market to drive up prices. All upwards pricing pressure on stocks is coming from public or quasi-public funds. Even recently, CSF and related entities had to announce they had no exit plan for fear of prompting a market collapse.
There is currently no stock market right in China, there is government mandated price levels in stocks. While that may stabilize the price levels, as the only real market participant Beijing got its wish but now needs to figure out how to extricate itself from a mess of its own making, and keep the market buoyant. Any hint of public selling will incur enormous losses for Beijing and the state owned banks that bailed out the market. Beijing needs to sell off its purchases but right now it’s the only player in the market forcing it to negotiate with itself.
Beijing stabilized the market. Now it has to deal with the unwanted lizards, snakes, and gorillas.