So while waiting in the airport to fly back to Shenzhen my Twitter feed was going crazy as the RMB and Chinese stock markets decided it had been a while since they had a proper freak out. So let’s get back into things and tell you what I’m going to do with the blog in 2016.
The PMI data releases and concerns about GDP growth might be on people’s mouth but that has nothing to do with what caused the past two days drop in the stock market. Like many recent violent up and downs, I don’t think you can pinpoint one factor. However, if I would point to one culprit, I would focus instead on the easing of lockup period from summer buying to prop the stock market. Now let me emphasize, that is just speculation, but that is a much more likely culprit than people all of a sudden waking up and seeing poor PMI data.
Despite so much focus on the decline in margin lending, as I have repeatedly noted, most of the buying over the summer to prop up the market was done with debt financed capital. Remember, the actual amount of equity capital used to buy equities was pretty small. Most of the capital came from commercial banks, which I still haven’t heard how they are accounting for this in their risk capital weighting, or from the PBOC lending directly to firms. One contact actually told me at the time that the “loans” were no obligation loans. Meaning, the public was essentially bearing all the risk. There are a couple reasons this matter. First, not that there are lots of great investment projects in China but this is tying up liquidity. Should come as no surprise that the PBOC began pumping back in liquidity earlier this week. Second, leverage is being created upon leverage. As Michael Pettis notes, this is like a thousand central banks creating money. Third, this increases the correlation between assets and risky assets at that. The more this goes on, the more the debt markets become correlated with the equity markets increasing the risks of a disorderly unwinding. Fourth, China finds itself in a difficult position in that it needs equity capital to buy equities but international investors won’t touch the stuff and the only people propping up the market are the public institutions with debt capital. China can not deleverage and keep the stock market up. Period.
The PBOC is in a difficult position of trying to let the RMB depreciate either by steering it that way or letting the market move it that way but without letting the drift become a route. Patrick McGee of the FT, who is as smart as they come, has a great short piece about how the PBOC is managing the RMB. Now I actually have some minor disagreement with his interpretation, but I want to emphasize, this is a case where reasonable people can have reasonable disagreements. Noting that the market price of the RMB actually increased Tuesday and why the PBOC lowered the RMB fix by 0.2 percent, he cautions not to read too much into a one day data point. Completely fair point. I actually interpret this slightly differently. For the past few weeks, the PBOC has been setting the RMB fix 0.2 percent lower daily, following the market which would end the previous day even lower the 0.2 percent. The PBOC would then set the fix 0.2 percent lower, until yesterday when it was still set 0.2 percent lower even though the market was higher. Here is how I would interpret this, though I want to emphasize this, I see and understand where he is coming from. The PBOC was the RMB to glide lower very softly but they also likely have some type of target they want to get to. As with virtually all Beijing economic and financial policy, they are content to let the market play the dominant role if, and this is a big if, if the market does what Beijing wants it to do. When the stock market goes up, Beijing is happy to let the market play a dominant role. When the market goes down, Beijing wants to step in and stop the market. Consequently, when the market increased the price of the RMB that went against Beijing policy designs, they decided to keep the relative downward trend in the RMB price. A major belief of mine is that you cannot believe the Beijing press releases but have to watch what they do. The PBOC may say they want the market to play a greater role and I believe that with the caveat that it is true when the result is one Beijing wants. However, anytime Beijing sees a result in the market they do not like, they will swiftly, adjust it.
One of the things that amazes me is just how dependent on Beijing even smart people become to direct the economy. China is in the middle of truly epic and historic asset price bubbles across essentially every asset class. Real estate, stocks, and bonds are all wildly over priced. Why I mention this is that so many people both Chinese and foreign essentially buy into the concept that that the laws of economics and finance do not apply to Beijing and as long as Beijing says it won’t be, it will never come to pass. The price of assets and imbalances are essentially ignored because well, Beijing will handle it. Anyone that points out the emperor has no clothes or that assets are over valued is called a doomsayer and not a true believer. Now I personally think the risk of a Chinese financial crisis is low, for very technical reasons, but I have no doubt that assets are wildly overvalued and will correct at some point. I have no doubt that the economy is in incredibly poor shape. I have no doubt that finances throughout China are highly stressed. There are very few things I think in economics and finance qualify as absolute laws. One of them is this: if something cannot go on forever, it will eventually stop.
After a break over the holidays with some time to refresh, I have come up with some new ideas to keep the blog fresh and interesting and more than anything, keep my interest. I still plan to do some granular detailed data work, but I also want to expand into writing about some bigger picture issues. By that I mean this: I originally started writing this blog about China to try and educate because I generally thought the level of knowledge of the Chinese economy was quite poor. I started it almost to try and educate. Now I feel some of the big picture data issue battles have been won. People no longer accept Chinese GDP data, in fact everyone takes it pretty much as art. What I can’t figure out are who are these people on surveys that still believe Chinese GDP data. I know most everyone that should be surveyed and no one believes it. People that know very little about China now know not to trust. However, there are more big picture issues that people don’t understand about how the Chinese economy works so rather than trying to focus so heavily on data and empirics, I’m going to include some broader issues. As an example, one issue that I plan to write about soon as the importance of seasonality when looking at Chinese data. By that I mean, people are talking about the Chinese economy stabilizing in December but that so obviously forget that this mostly likely is nothing more than the pre-Chinese New Year bump as companies stock pile for the one month shut down. I’ll get into questions like that in more detail. The basic idea is simply trying to help people understand the Chinese economy better, but if there are questions you might want answered, please feel free to email. Happy New Year.