Stock-market-by-diktat not working for China

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The whole stock-market-by-diktat thing is not working out so well for China, or for the rest of the global economy.

China suspended stock trading nationwide on Monday after a 7 per cent loss in the benchmark index of Shanghai and Shenzen shares triggered a newly implemented circuit-breaker.

Losses spread globally, sending the Dow Jones industrial average down 1.58 per cent. At midday the index was down 2.4 per cent, which, if sustained to the close, would have been its worst opening day of January since 1932.

The drop wasn't so much driven by news that China's economy was faring worse than expected, courtesy of a disappointing survey of manufacturers, but instead fear that investors might actually get to put what they already know about China into practice.

China, you see, has spent the past six months furiously suppressing the price-discovery mechanism of its stock market, bullying, intimidating and sometimes arresting those it thinks contributed to embarrassing losses last summer and implementing concrete measures to stifle selling and support prices.

One of those measures, a six-month moratorium on sales by institutions which hold more than 5 per cent of a stock as well as by corporate executives and directors, is due to expire January 8.


So it wasn't news that China is slowing - we already knew its smoke-stack economy has been hard hit - it was the prospect of this knowledge being made just a bit more manifest through stock prices which caused the falls.

The Chinese government indicated midweek it will keep in effect its ban on share sales by listed companies' major shareholders until the government publishes new rules on such share disposals. That ban has locked up an estimated 1.24 trillion yuan ($US190.23 billion) worth of shares.

China's attempts to micro-manage its share markets are both self-defeating and bad for the rest of the global economy.

Self-defeating because they send an unambiguous signal: stay away if you have a choice. Foreign investors are reluctant to buy into something that may later prove difficult to sell, especially if the government is seen as the risk that may pose that difficulty.

So while China may have felt compelled to stop the losses last year, its measures to repress price discovery will tend ultimately to drive prices down rather than up. Investors, quite reasonably, want better compensation for the risk that they'll not be able to get their money back easily or quickly.

In order to be able to ultimately row back from its tactics, China depends on the macro environment for Chinese stocks to improve, something which may not happen for the broad market for some time.

Here today, yuan tomorrow

As Monday's trading demonstrates, all of this isn't simply a problem for China. The stock market of the world's second-largest economy, even if tightly controlled, is going to have a substantial impact on the rest of the world. Even if the information content of Chinese stock prices is diluted by official control, volatility, which is one likely output of price suppression, will have an impact elsewhere.

None of this is to say that the rest of the world should have no worries about China other than how it manages its capital markets. Growth is clearly slowing, and while long term the change will be a very good thing, an ongoing transition to a consumer-oriented economy is going to pose problems for a world dependent on Chinese demand for raw materials.

China's yuan hit its lowest levels against the dollar on currency markets since May of 2011, carrying on a slide in both mainland and offshore markets. China has good reason to want a weaker yuan, whose value it tightly controls. A less valuable currency will be good for exports, though it may increase the pent-up desire of Chinese holders of yuan to move money offshore.

At the same time, a cheaper yuan makes it that much tougher for other economies, not only in terms of competing with China but also in that it sends a further and powerful deflationary force into a global economy still suffering from too little inflation.

China is suffering a substantial outward flow of capital as its people try to move money offshore, both because they may fear further yuan depreciation but also as anti-corruption crackdowns make the idea of having assets beyond the reach of authorities attractive. China's central bank and its commercial banks sold a net $US337 billion of foreign exchange between January and November, indicating large amounts of capital moving out.

China is unlikely to suddenly see the virtues of price discovery, which means the rest of the world will have to live with the resulting risks.