Never mind Greece, WTF is going on with China's plunging equity markets?

Droll washingtonpost.com caption: "The Extraordinary League of Punditry requires this stock photo of an investor looking at a red screen when writing about the ongoing turmoil in Chinese equity markets."

"The rout in Chinese shares has erased at least $3.2 trillion in value, or twice the size of India’s entire stock market."

-- from Bloomberg's report yesterday, "Chinese Trading
Suspensions Freeze $1.4 Trillion of Shares Amid Rout"

by Ken

"Nothing to see here," reads the deck on Tufts Professor Daniel W. Drezner's washingtonpost.com post "The politics of China's stock market collapse" -- "just the meltdown of Chinese equity markets."

"So while every international affairs pundit and their mother are focused on the travails of an economy the size of Louisiana," Drezner begins his piece, "the second-largest economy is experiencing a teeny-weensy stock market meltdown." He quotes from Fox Hu's Bloomberg report, adding dramatic emphasis for the sentence I've pulled out above:

Almost 200 stocks halted trading after the close on Monday, bringing the total number of suspensions to 745, or 26 percent of listed firms on mainland exchanges, according to data compiled by Bloomberg. Most of the halts are by companies listed in Shenzhen, which is dominated by smaller businesses.

The suspensions have locked up $1.4 trillion of shares, or 21 percent of China’s market capitalization, and are becoming increasingly popular as equity prices tumble. If not for the halts, a 28 percent plunge in the Shanghai Composite Index from its June 12 peak would probably be even deeper….

The rout in Chinese shares has erased at least $3.2 trillion in value, or twice the size of India’s entire stock market. The Shenzhen Composite Index has led declines with a 38 percent plunge since its June 12 peak, as margin traders unwound bullish bets (emphasis added).

Oops!

Well, it seems what's happened isn't quite as dramatic in real-world terms as it may appear, and doesn't really tell us anything significant about China's "real" economy, which was already known to be slowing down but shows no signs of being in significant trouble. For one thing, Chinese stock markets don't have anything like the importance of markets in the world's other major-player economies.

Chinese equity markets are pretty thin and small as a percentage of GDP compared to the developed world. Less than 20 percent of household assets were in the stock market. Financially, it would be difficult to argue that this is China’s Lehman moment.

But more important, what the Bloomberg report describes as "at least $3.2 trillion in value" lost was no such thing, if by "value" we mean, you know, value. Drezner insists that everyone was well aware that China has been in the grip of an economic bubble so enormous that something had to give. In fact, stock prices had soared so wildly above companies' actual asset values that the market still has a heap of correcting to do.

The pre-panic run-up had all the makings of irrational exuberance [the link is to a Wall Street Journal piece headlined "How Chinese Stocks Fell to Earth: 'My Hairdresser Said It Was a Bull Market' " -- Ed.]. Furthermore, despite the large decline in equity prices, Chinese stocks are still massively overvalued compared to where they were last fall. So unless the “Xi put” is way larger than the “Greenspan put” [defined at the link as "a description of the perceived attempt of the then-chairman of the Federal reserve Board, Alan Greenspan, of propping up the securities markets by lowering interest rates and thereby helping money flow into the markets" -- Ed.] was back in the day, Chinese stocks still have a long way to fall [my emphasis added].

That's right, there should still be a lot of correcting to come.

"CHINESE STOCKS STILL LOOK OVERVALUED"

[Click to enlarge.]

Peter Thal Larsen begins the Monday NYT DealB%k post linked above: "For all the Chinese authorities’ increasingly overt meddling in the market, Chinese shares are still looking expensive. Even after the country’s main market indexes plunged roughly 30 percent in three weeks, on any fundamental analysis, they have further to fall."

A BUBBLE THE SIZE OF THE ONE THAT'S
BURSTING IN CHINA CALLS FOR COMMENT

The "Xi" of Drezner's "Xi put," of course, would be China's ever more powerful president, Xi Jinping (who you'll recall is also general secretary of China's Communist Party and chairman of its Central Military Commission). Xi, Drezner notes, "has spent the past few years centralizing political power [this link is to an April New Yorker profile of Xi by Evan Osnos, the magazine's former China correspondent -- Ed.] to a greater extent than anyone since Deng Xiaoping." And as is suggested by Drezner's post title, "The politics of China's stock market collapse," he's most interested in how Xi has been dealing with these developments and how they may affect his future powers and his promised economic reforms.

Drezner is intrigued by the fact that the bubble "was allowed to form in the first place," and looks to two very different explanations.

From The Economist's "Free exchange" blog comes the argument "that the stock market was pumped up to enable and legitimize economic reforms."

The government has staked much credibility and prestige on the stockmarket. When the going was still good, the official press was chock-a-block with articles about how the rally reflected the economic reforms that Xi Jinping, China’s top leader, was set to push. Li Keqiang, the premier, said repeatedly that he wanted equity markets to provide a bigger share of corporate financing—comments, from punters’ perspective, not unlike waving a red cape in front of a bull. The sudden end to the rally is the first major dent in the public standing of the Xi-Li team. The botched attempts to stabilise the market only make them look weaker, giving succour to their critics.

Whereas Andrew Erickson and Gabe Collins argue in the Wall Street Journal ("Stock Slump Casualty: The Myth of Chinese Exceptionalism") that the culprit was bureaucratic inertia:

So why wasn’t China’s vaunted bureaucracy able to head off this policy train wreck? Well-documented bureaucratic turf wars [behind Financial Times paywall -- Ed.] between the People’s Bank of China (PBOC) and China Banking Regulatory Commission (CBRC) helped sow the seeds of some of China’s most pressing current economic problems—such as ballooning debt and use of shadow banking. Such infighting continues impeding the Chinese government’s response to the current market downdraft….

As such, the PBOC likely faces significant political pressure to continue pumping the stock market up, as this helps distract the populace from the fact that the market for residential real estate—the prior hot investment area—is flagging. For its part, the CBRC has likely been “captured” by the very banks it is supposed to regulate, further contributing to amplified systemic risk from shadow banking activities that are tougher to track and regulate than lending conducted through normal bank channels. Ultimately, conflicting bureaucratic priorities and infighting send contradictory messages to investors and likely fuel additional market instability.

Drezner takes no position here, but notes, "The one thing that these analysts and everyone else agrees upon is that this will put a serious dent into Xi Jinping's efforts to liberalize the Chinese economy ranging from capital account liberalization to simply letting the market play a 'decisive' role in the economy."

He points out that "China’s government has recently been extremely sensitive to what seems like minor matters," and in the matter of what he calls the government's "increasingly desperate series of interventions" he cites a report by the Financial Times's Tom Mitchell [again, behind FT paywall] pointing out that "the market was not malfunctioning," and that "if anything, a three-week, 30 per cent correction after a 12-month, 150 per cent surge seemed like a welcome adjustment." But, says Mitchell,

for Mr Xi’s administration, letting the market find its own level apparently involved a loss of control — and a level of risk — that it could not accept. It does not bode well for the rest of his reform agenda. [I had to put that in boldface. -- Ed.]

Drezner, referring back to a March post of his, "Stress-testing the China model" (whose subhead was "The Chinese economy is due for a major league correction. How China's political system handles this will be interesting"), says, "The China model appears to be failing this stress test." And here's where all that power President Xi has consolidated unto himself comes into play.

It will be possible but difficult for him to fob off blame for this setback onto someone else. And in the mind of ordinary Chinese citizens, Xi’s leadership will not look quite so all-powerful from here on in.

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