China Destroyed Its Stock Market in Order to Save It

When you run out of magical intervention tricks in your bag the best way to handle the inevitable is a controlled demolition. Although the crisis is far from over, it alleviates the pain for the short-term time being. You know the situation is dire when the Communist Capitalists force investors to stay in by banning all selling of stocks for months, forcing you to shoulder the loss, in order to stem the tide.

 

Last week, China destroyed its stock market in order to save it. Faced with a crash in share prices from a bubble of its own making, the Chinese government intervened ruthlessly, and recklessly, to turn those prices around. Its heavy-handed approach seemed to work, for the moment, but only by severely damaging far more important goals and ambitions.Prior to the crash, China’s stock market had enjoyed a blissful disconnect from reality. As China’s economy slowed and corporate profits declined, share prices soared, nearly tripling in just 12 months. By the peak, half the companies listed on the Shanghai and Shenzhen exchanges were priced above a preposterous 85-times earnings. It was a clear warning flag — one that Chinese regulators encouraged people to ignore. Then reality caught up.

At first, when prices began to fall, the central bank responded by cutting interest rates and bank reserve requirements — measures to inject more money that had never failed to juice the market. But prices continued to fall. Then the government rallied the major brokerages to form a $19 billion fund to buy shares and waded directly into the market to buy stocks too. A few stocks rose, but most fell even further.

Chinese regulators, who had been trying (ineffectually) to rein in risky margin lending, now suddenly reversed course. They waved rules requiring brokerages to ask for more collateral when stock prices fall and allowed them to accept any kind of asset — including people’s homes — as collateral for stock-buying loans. They also encouraged brokerages to securitize and sell their margin-lending portfolios to the public so that they could go out and make even more loans. All these steps knowingly exposed major financial institutions, and their customers, to much greater risk. Yet no one will borrow if no one is confident enough to buy, and the market continued to fall, wiping out nearly all its gains since the start of the year.

By this point last week, China’s state media was talking openly of a “war on stocks.” And in that war, China’s leaders chose to employ the nuclear option: In effect, they closed down the market and outlawed selling. As of the morning of July 10, about half of China’s 2,800 listed companies filed to suspend trading. Many of their owners had pledged shares as collateral for corporate and personal loans and were facing margin calls that would cause them to lose control of their companies. Chinese regulators also banned major shareholders from selling any shares for the next six months. Additionally, they directed companies to start buying back their own shares and instructed state-run banks to provide whatever financing was needed.

But the real turn in the market came when China’s Ministry of Public Security — the no-nonsense tough guys normally tasked with cracking down on political dissent — announced that it would arrest what it called “malicious” short-sellers. It was clear, however, that this meant anyone whose selling (not just “short” selling) interfered with the government’s efforts to boost prices. The announcement cast a chill over the market. I have heard multiple reports of Chinese brokers refusing to accept sell orders for fear of angering the authorities. So when we say China’s stock market stabilized, we need to put quotation marks around the word “market.”

China’s temporary success at manipulating a share-price rebound has come at a terrible longer-term cost. Two years ago, China’s leaders adopted “market forces will be decisive” as the guiding principle behind a much-lauded push for reforms needed to reinvigorate China’s slowing economy. That principle now lies in ashes.

For years, China has dreamed of Shanghai’s becoming a global financial center. Now, one analyst at the global investment firm Julius Baer told the Financial Times, “confidence in the local Chinese equity market has been shattered and is unlikely to come back anytime soon.” Just a few weeks ago, observers confidently predicted it was “inevitable” that domestic Chinese stocks would soon be added to the major global indices that serve as benchmarks for professional investors. Today, with a mere rump of China’s stock market trading at all, and with investors afraid they will be thrown in prison for selling at the wrong time for the “wrong” price, it’s inconceivable.

Full article: China Destroyed Its Stock Market in Order to Save It (Foreign Policy)

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