China’s economy: the gyre widens

I’m sure many readers are familiar with W. B. Yeats‘ (in)famous poem, ‘The Second Coming‘.  Written in the chaos and uncertainty following the First World War, it expresses the anguish of many and their loss of belief in old ways and older promises.

Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world …

That’s how things seem to me in the world today, in many senses.  One of them is economic – and China’s stock market, which we’ve visited several times this month, is showing unmistakeable symptoms of ‘falling apart’ because the (State-mandated and -imposed) ‘center cannot hold’.  Yesterday stocks there suffered their worst one-day loss since 2007, and some analysts are predicting further losses.  This morning has seen more wild price fluctuations.  As the Telegraph noted:

The violence of the moves unnerved investors worldwide, stirring fears that the Communist Party may be losing control after stoking a series of epic bubbles in property, corporate investment and equities to keep up the blistering pace of economic growth.

. . .

Mark Williams, chief Asia strategist at Capital Economics, said the Chinese authorities appear to have been testing the waters to see what would happen if they stopped intervening. The market verdict was swift and brutal.

“They have got themselves into a very difficult situation. They have put a lot of credibility on the line to shore up prices and this credibility has been badly damaged,” he said.

. . .

The Chinese media reported on Monday night that the state regulator is ready to intervene with yet more stock purchases. It has already bought an estimated $250bn of equities and has borrowing lines for a further $450bn if necessary.

Western banks say they are coming under heavy pressure from Chinese officials to refrain from negative comments. They are effectively gagged if they wish to do business in China.

“Large parts of the market are closed, and those stocks that are still trading are selling off regardless of support measures. Clearly something very serious is happening,” said one economist.

The long-standing assumption that the Chinese authorities know what they are doing has been shattered.

The government’s heavy-handed measures include a ban on short sales and on new share issues, as well as pressure on the 300 largest companies to buy back their own stock, and forced purchases of stocks by brokerage houses.

Many investors are effectively trapped with margin debt used to buy the stocks. These liabilities cannot be covered without selling the stocks. The longer the market remains partially frozen, the more likely it will lead to extreme stress.

David Cui, from Bank of America, said $1.2 trillion of stock holdings are being carried on margin debt. This is 34pc of the free float of the Shanghai and Shenzhen stock markets. “When the market ultimately settles at a level that can be sustained on fundamental reasons, we expect that the financial system may wobble, due to high contagion risk,” he said.

“Most leveraged positions may suffer from losses ultimately, likely in trillions (of yuan). The risk is that the unwinding of the leverage will be disorderly: due to implicit guarantees behind most shadow banking products, investors could easily panic,” he said.

Mr Cui said the brokers and trusts have barely 1.6 trillion yuan ($260bn) to absorb losses and may be overrun. “Given the particularly thin front line of the financial institutions, we suspect that it’s a matter of time before banks may have to face the music,” he said.

This in turn risks setting off a “bank run” on the shadow banking system as investors lose trust in wealth management funds, fearing that their deposits in the $2.1 trillion industry no longer have an implicit guarantee.

There’s more at the link.

China’s economic woes are spreading around the globe, causing ripple effects that threaten major calamity to smaller markets.  From the same Telegraph report:

Brazil, Russia, South Africa and a string of commodity states face a double-barrelled stress test. The Chinese are freezing imports just as the US Federal Reserve drains worldwide dollar liquidity and prepares to raise rates, calling time on emerging markets that have together borrowed $4.5 trillion in US currency.

The Brazilian real fell to a 12-year low of 3.38 against the dollar on Monday. The South Africa rand hit a record low of 12.69. The Russian rouble flirted with the danger line of 60. It was the same story across much of the emerging market nexus.

“One by one the dominoes are starting to fall,” said Societe Generale.

The trouble is, no-one seems to know why the market crashed so abruptly.  Bloomberg reports that confusion reigns.

It’s days like Monday that reassure Tony Hann he was right to avoid stocks in mainland China.

The severity of an 8.5 percent drop in the Shanghai Composite Index is bad enough, but what irks him the most is not knowing why it tumbled so much. In a market where unprecedented intervention has made government money one of the biggest drivers of share prices, authorities aren’t transparent enough for investors to make informed decisions, said Hann, the head of emerging markets at Blackfriars Asset Management Ltd.

Monday’s plunge was all the more surprising because it followed a government rescue package that had helped drive a 16 percent rally since July 8. That support appeared to vanish without warning, leaving analysts guessing whether authorities shifted their policy stance or just got overwhelmed by a flood of sell orders. After the close of trading, the securities regulator denied speculation that the government has exited the stock market.

Investors “are concerned and lost,” said Alex Wong, a Hong Kong-based asset-management director at Ample Capital Ltd., which oversees about $155 million. “China’s market is distorted, so you can’t sell short very confidently and you can’t buy up very confidently either.”

. . .

The International Monetary Fund has urged China to eventually unwind its support measures, saying share prices should be allowed to settle through market forces, according to a person familiar with the matter, who asked not to be identified because the talks are private.

“The markets in China now are not really markets,” Donald Straszheim, head of China research at New York-based Evercore ISI, said on Bloomberg Television last week. “They are government operations.”

Again, more at the link.

This is what happens when governments delude themselves that they can dictate to markets.  Markets are affected by all sorts of factors, sentiment and delusion being high among them;  but at bottom, they’re subject to mathematical reality.  As economist Herbert Stein famously put it, “If something cannot go on forever, it will stop.”  His eponymous law applies in China just as much as it applies in the USA.  The Chinese government can demand, dictate and decree until it’s blue in the face, but sooner or later economic reality is going to override the delusions of bureaucrats and politicians – just as it appears to be doing right now.

King Canute has gone down in history for demonstrating the folly of imperiousness.  One wonders whether it’s time for the Chinese government to decree that his example should be studied by its bureaucrats and commissars.  The lesson might be unpalatable, but the insights it provides might be very helpful at a time like this.



  1. A biz-jet sales magazine arrived last week (talk about wrong mailing list. Anyway). It had a propaganda piece from several Chinese aviation groups talking about civil aviation in China, and the slips are telling. "According to publicly available data, in the year 2012, 134 airports out of a total of 183 in China took a combined loss of 2.9 billion yuan. The majority of loss generation airports were regional aviation airports. In the year 2013, nearly 70% of Chinese airports saw an annual passenger throughput of less than 1 million." And so on. basically, aviation in China runs at a major loss, they are building airports for the passengers and flights that are not happening, and most civilian non-airline aviation (and I suspect a chunk of domestic airline traffic) is for Party members and government officials who are encouraged to fly to help make work at the airports. Civil airports are defined as "public welfare first, and then profit." So despite the glossy ad and encouragements about the booming civil aviation sector in China, it barely exists and costs more than it generates. Like so much else in the Chinese economy. And those few places that have biz jets will dump them ASAP if the economy starts to stagger, lest they attract more ire from the Communist Party.


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