The communist Chinese government has now tasted the bitter medicine of the downside volatility that accompanies capitalism. That nation’s stock market has sold off $3 trillion — some 30 percent during the past four weeks.
To counter this major market downturn, the government had unleashed a barrage of measures that run counter to a free market:
• Extended $40 billion of loans to brokerage firms to buy stocks.
• Ordered large shareholders to not sell their equity holdings for six months.
• Suspended trading in nearly half the country’s stocks.
China’s leadership is disregarding the good news. That — according to Scott Collins of Fiduciary Wealth Advisors, as of July 10 — is that the Shenzhen Composite is still up 43 percent year-to-date and 83 percent over the last 52 weeks.
Beijing’s detractors still criticize the government for not doing enough. For instance, they pointed out that state-led buying has mostly focused on large-cap names, such as the country’s top four state-owned lenders. They believe a more effective and equitable equity stimulant was Tokyo’s 2010 purchasing of exchange-traded funds. This action helped drive up the overall Japanese stock market.
In Western democracies, we tolerate volatility. But in China, the malaise of its equity markets has translated into social unrest that has frightened the nation’s leaders. Despite talk of liberalizing Chinese markets, their financial markets remain tied to their political institutions. Many Chinese investors even expect their president, Xi Jinping, to take the necessary steps to recoup their losses.
James Chanos, who runs New York hedge fund Kynikos Associates, said: “The story has yet to play out. As long as China adds credit faster than its growth, the real story is months and years ahead.” Chanos became bearish on China in 2010 over the significant increase in debt throughout the Chinese economy.
Until this crisis, economists had praised the Chinese government for its expertise in managing economic matters. For instance, its massive stimulus program launched in late 2008 helped the Chinese economy weather the global financial crisis. The downside was that the Chinese government incurred a large amount of debt, encouraged a real estate property bubble and figuratively “built bridges to nowhere.”
Buying on margin has contributed significantly to the equity downdraft. Margin financing soared almost five-fold over the past year.
The selloff in China’s stock market has global repercussions. It weighs down demand for goods and services worldwide. China is one of the world’s largest consumers of oil, metals and food. Copper recently fell to a six-year low. Crude oil prices have weakened.
What has been America’s historical response?
In general, our government relies heavily on the market to weed out irrational optimism or pessimism.
But our markets are not entirely free from government influence. Our government did purchase GM and AIG during our Great Recession to ameliorate our problems.
We pressured JPM to purchase Bear Stearns.
The Federal Reserve, especially since 2008, has flooded our economy with liquidity to quell market panics and increase demand for our goods and services. For several years, we even banned the short selling of financial companies because we believed that banks were “too big to fail.” Short selling is when investors borrow shares that they do not own and sell them in the hopes that they can then buy these stocks back at lower prices.
Evercore ISI China stock watcher Donald Straszheim stated, “Chinese authorities have gone all-in.”
The Chinese command economy does hold a big stick, but not even they can defy the laws of supply and demand.
I agree with the Nobel laureate, Milton Friedman, who put his faith in the markets as the best way to guarantee the efficiency of production of goods and services — the ultimate measure of wealth in the economy.
—Sarasota resident Ernest “Doc” Werlin spent 35 years in fixed income as a trader and corporate bond salesman, including time as a partner at Morgan Stanley in charge if corporate bond trading. Send suggestions and comments to doc.werlin@gmail.com. Read past columns at docwerlin.com.
DOC’S PRESCRIPTION
The communist Chinese government has now tasted the bitter medicine of the downside volatility that accompanies capitalism. That nation’s stock market has sold off $3 trillion — some 30 percent during the past four weeks.
To counter this major market downturn, the government had unleashed a barrage of measures that run counter to a free market:
Originally published in the Sarasota Herald-Tribune
