Submitted by Patrick Chovanec via ForeignPolicy.com
,
During the Vietnam War, surveying the shelled wreckage of Ben
Tre,
an American officer famously
remarked
, “It became necessary to destroy the town to save
it.”His comment came to epitomize the sort of
self-defeating “victory” that undoes what it aims to achieve.
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.
The relentless crash was intensified by a new factor in
Chinese markets: margin lending.Chinese punters were
borrowing in large sums, from both brokerages and more shadowy
sources — like “
umbrella trusts
” and peer-to-peer lending websites — to buy shares, with the
shares themselves as collateral. At the peak, according to
Goldman Sachs
, formal margin lending alone accounted for 12 percent of the
market float and 3.5 percent of China’s GDP, “easily the highest in
the history of global equity markets.” Margin loans served as
rocket fuel for the market on its way up, but prices began to fall
and borrowers received “margin calls” that forced them to liquidate
their positions, pushing prices down further in a kind of death
spiral.
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.
It didn’t have to be this way.Some compare China’s
intervention to the U.S. Troubled Asset Relief Program (TARP), but
the difference is striking. TARP didn’t try to stop market prices
from falling; it focused on containing the damage. If Chinese
authorities identified a large securities firm that was at risk of
failing from bad margin loans and stepped in to prevent a chain
reaction, that would make more sense — and do a lot less damage —
than trying to prop up the entire stock market by fair means and
foul. Memories are short, but in 2007, China allowed an equally
large stock bubble to collapse without its economy suffering
irreparable harm.
Caixin, one of China’s most prominent financial magazines,
argued
recently that this time around, the government “had no reason
to intervene” to prevent a much-needed market correction and had
grossly overreacted.
China needs a functioning stock market that allocates
investors’ capital to the most promising enterprises. This means
prices that aren’t obedient to the whims of the state, or the
party.
China may have arrested the stock market’s fall by threatening
to arrest sellers. But when it did that, it destroyed the town it
was trying to save.
