A circuit breaker: a symbolic market tool - Sara Hsu

Sara Hsu

China´s stock market regulators launched the idea of a circuit breaker, to avoid heavy swings at the markets. The market would be stopped for 30 minutes after an upswing or downswing of more than five percent, at most once a day. Highly symbolic, writes financial analyst Sara Hsu in the Diplomat, and it cannot be a proxy for real reform.

Sara Hsu:

For the stock market to truly be stabilized, deeper reforms are needed. For one, the proportion of institutional to retail investors must rise, as the former tend to be long-run market participants, while the latter tend to trade with higher frequency and have less expertise in market fundamentals and other aspects. To address this, officials have allowed local government pension funds to participate in the stock market. Second, the stock market should become more representative of the economy, with a greater number of privately owned firms listed. Officials should refrain from frequently halting IPOs. While this will likely mean that volatility in the stock market will have a greater impact on the real economy than it does at present, it will also mean that stock market fluctuations should logically mirror broader economic indicators and therefore should be easier to interpret for retail investors. Third, complementary reforms in the financial system must be carried out to expand private credit. The banking system suffers from insufficient competition and dampened profitability due to the dominance of the Big Four state-owned banks. The corporate bond market is immature and underused. Reforms and expansion of private credit in banks and bond markets would theoretically reduce the cost of funding in the financial market as a whole, including in the stock market. 

The circuit breaker proposal has made the government look active and concerned, although excessive market intervention (with poor results) has been blamed for reducing market confidence. The proposed action may not be overly impactful, since a circuit breaker is already in place. Moreover, deeper reforms must be carried out within China’s stock market and broader financial markets if Beijing is to root out inefficiencies, including irrational volatility.

More in The Diplomat.

Sara Hsu is a speaker at the China Speakers Bureau. Do you need her at your meeting or conference? Do get in touch or fill in our speakers´request form.
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Bankers win, retailers lose in Hong Kong - Wei Gu

Wei Gu

The recent financial turmoil has different effects on different industries, notes Wei Gu, wealth editor of the Wall Street Journal in Hong Kong. While sales have dropped in retail, as mainland shoppers drop out, bankers are extremely busy helping mainland customers to change a devaluating Yuan into other currencies.

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How Xi Jinping let financial regulators run out of control - Victor Shih

Victor Shih

The central government wrongly used the upswing in stock markets as a proxy for real reforms, says associate professor Victor Shih in the Washington Post. Until those shares came down and created mayhem in China and globally. ""In dictatorships, when things are going well, nobody wants to end the party."

The Washington Post:

“The entire policy establishment was thinking they had found the magic bullet for corporate finance in China and not really thinking about where the money comes from," ... said (Victor Shih, associate professor at the University of California at San Diego’s School of Global Policy and Strategy). 

For Shih, the sorry episode also reflected a more fundamental flaw in China’s system, especially with power so centered in one man. 

"In dictatorships, when things are going well, nobody wants to end the party,” he said. “When anything goes well in China, people can attribute that to the top leader. But it would be very difficult for anyone to come and say, 'Things are not going well; it’s a bubble and it’s about to crash.'" 

"Had power been a bit more decentralized, people would have come to say, 'Lets end the party.' There would be less fear of offending any particular leader." 

Xi’s centralization of power, some experts and foreign business leaders say, has also undercut a strength of the Chinese system — decision-making by consensus, in which policy was implemented only after careful consultation and cautious experimentation. Today, they say, policy seems less considered, more haphazard.

More in the Washington Post.

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One China, three worries - Arthur Kroeber

Arthur Kroeber

Economist Arthur Kroeber spells out three worries for China in the Business Standard. The stock market, short-term growth and long-term growth and reform. Here is his first worry. Damage to the economy seems limited.

Arthur Kroeber:

The stock market: It is clear that China has just experienced a leverage-driven bubble disconnected from the realities of economic activity and corporate earnings, and that the government has severely damaged its credibility first by encouraging retail investors to join the party and then by its mind-boggling interventions to stem the rout. Yet it is also clear that forecasts of contagion from the bear market in stocks to the real economy via a negative wealth effect among individual investors are wide of the mark. 

Only about seven per cent of China's population is active in the stock market and household balance sheets are dominated by property, bank deposits and wealth management products. Equity losses will pinch household wealth, but not undermine it. 

Other potential economic knock-on effects are comparably modest. Equity financing is a minor funding contributor to corporations, which rely mainly on retained earnings and bank loans. Contagion to the financial system would be a worry if brokers started going bust as a result of reckless margin lending, but this is not happening. Chinese brokers are not dangerously leveraged; they are cash rich. Shanghai volumes are actually higher now (60 billion shares a day in July) than they were back in May (54 billion). Given the continued vitality of trading activity, value added in financial services - which boosted gross domestic product a bit during the bull run - does not look to drop that much.

Two more worries in the Business Standard.

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Young investors hard hit by stock volatility - Shaun Rein

Shaun Rein

For veterans the 30% drop of Chinese stock markets last week was not really a surprise, but this time especially young inexperienced investors have been hit hard, tells business analyst Shaun Rein author of The End of Copycat China. Over the past month 7 million new accounts were created, mostly by investors under 30 years. That might his consumer confidence, says Rein.

Click here for the audio

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The growing systemic risks in China - Shaun Rein

The current mayhem at China´s stock market might be some short-term panic selling, but business analyst Shaun Rein points at the systemic risks in China, as a growing number of companies use their shares as collateral, he warns at Bloomberg. For US companies, the current fallout seems less problematic.

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The popping exuberance at Chinese stock markets - Paul Gillis

Paul Gillis

Many analysts have been looking at the government for a solution of the dropping stock markets in China. But accounting professor Paul Gillis says investors - including the foreigners - should have a look at their own "irrational exuberance", he tells CNBC.

CNBC:

Some of the most popular Chinese U.S.-listed stocks are Internet companies with a "VIE" structure, which stands for variable interest entity. Since China restricts foreign ownership in the domestic shares, the VIEs are a workaround that gives the companies access to U.S. capital through the NYSE and Nasdaq.   

But the VIEs give foreign investors no actual share of ownership in the Chinese companies, no say in the company's direction, and could actually be deemed illegal by the China's court system at any point. Not to mention, the SEC doesn't require the VIEs to disclose some past scandals, such as bribery and corruption. 

"I've never seen investors invest in things they don't own before," said Paul Gillis, editor of The China Accounting Blog and an accounting professor at Peking University... 

"It does seem that the government has lost control of the market and we are in a 1929-type crash situation," said Gillis. "This is a case of irrational exuberance that finally popped."

More at CNBC.

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Stock markets: more room to fall - Victor Shih

Victor Shih

China´s stock markets might have dropped already more than 30%, but there is more room to fall, tells financial analyst Victor Shih in Quartz. Existing sell orders will put downward pressure on the market, he says.

Quartz:

The Shanghai Composite Index fell 1.3% on July 7, days after the Chinese government vowed to prop the benchmark index up. It has a lot farther to fall, says Victor Shih, professor at University of California, San Diego. 

“[E]ven with a government rescue, it could be quite some time before the backlog of existing sell orders are cleared,” Shih tells Quartz. “This will continue to out downward pressure on the market.”... 

When stocks drop enough that brokerages get twitchy about ever being able to get their loans back, they demand that their clients pony up more money or stocks as a deposit. If these “margin calls” force enough liquidation at the same time, it can create a cascade of falling share prices, that in turn spark more margin calls. 

In China’s case, a lot of that margin finance flowed into the most speculative part of the market, super-volatile small-cap stocks, says UCSD’s Shih—the stocks that have been tanking the hardest. 

China tries to prevent margin call disasters with a rule suspending a stock from trading for a day once it’s lost 10%. But that does not actually solve the problem—it just stalls it.

“When the stocks began to sell off, margin calls rolled in,” says Shih. “However, because of the rule… margin lenders could not liquidate positions in many cases.” Even though not all the positions have been sold out, stocks are down to practically where they were before the recent several-month bubble.

More in Quartz.

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What does the government wants at the stock markets - Arthur Kroeber

Arthur Kroeber

A sky-high rally, a scary fall and unprecedented government action to stop that fall. Is the government for the first time losing its dominance to market forces, as some suggested? Financial analyst Arthur Kroeber does not think so, he tells Globe and Mail.

The Globe and Mail:

For the Chinese leadership, however, the possibility of more balance in Shanghai and the hope that Shenzhen will also find a more stable footing may be good enough. 

“I don’t think they need a big rally. As long as they can stop the losses, they’re probably going to be happy,” said Arthur Kroeber, the Beijing-based head of research for Gavekal Dragonomics. 

“This is not a government that believes in unfettered markets,” Mr. Kroeber said. “They never have, they never will. They believe markets are tools to greater ends – and if things seem to be going out of kilter, they’ll adjust things.” 

Still, if the coming days bring a further rout, China has shown its willingness to intervene dramatically to prop up share prices – suggesting it will use more firepower if needed.

More at the Globe and Mail

Arthur Kroeber is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´ request form.

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