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.

#

How Glenn Greenwald Made President Obama's Meeting WIth China's President Xi Jinping In The California Desert A Drag

Walter Annenberg was connected. He built his familiy's business from publishing a shady race track form to an empire publishing TV Guide, Seventeen, the Philadelphia Inquirer. Nixon appointed him Ambassador to England in return for his financial and editorial assistance to the Republican Party. In 1976 the Queen made him an honorary Knight Commander of the Order of the British Empire (KBE), something every Republican plutocrat aspires to. His palatial estate in Rancho Mirage, our near Palm Springs, was often billed as Camp David West and hosted events for Nixon, Ford, Reagan, both Bushs, Margaret Thatcher, as well as for every puffed-out monarch that had thus far escaped being decapitated-- from Queen Elizabeth to the last criminal Shah of Iran. Reagan appointed his second wife, Leonore, Chief of Protocol for the State Department.

Today, his Sunnylands estate, is still used for diplomatic events and in 2013-- June 7 and 8, it was the site of the "shirtsleeves summit" between Obama and Xi Jinping. As Bobby Flay was preparing dinner to delight the two presidents' taste buds, The Guardian was publishing an article by Glenn Greenwald, Obama orders US to draw up overseas target list for cyber-attacks. This was especially ill-timed for Obama who wanted to meet with President Xi to get on his ass about cyberattacks from China.

President Obama said Friday that he told China's President Xi Jinping that it's critical they come to an understanding on how they'll work together on cybersecurity, one of the most contentious issues facing the two nations.

…China has been widely linked to network break-ins of numerous Western companies and agencies. And Obama issued an executive order this year to compel government and industry to share intelligence about network breaches, mainly to protect the nation's infrastructure.

The Pentagon also blamed China for cyberattacks in its annual report to U.S. lawmakers on Chinese military capabilities. The report, published in May, stated that some of the recent cyberattacks in the United States appeared "to be attributable directly to Chinese government and military."

Xi didn't address those charges but said China was also the victim of cyberattacks. He added that through good faith negotiations the U.S. and China could make the issue "a positive area of cooperation."

Greenwald's article included an unpublished Presidential Policy Directive issued in October 2012, which, according to Michael Gurnow's book, The Edward Snowden Affair, "instructs the secretary of defense, director of national intelligence and head of the CIA to create a list of overseas targets of 'national importance' for possible cyberattacks. The purpose of the tentative attacks is not heightened defense, retaliatory action or even as a pre-emptive measure. It is to 'advance U.S. national objectives around the world with little or no warning to the adversary or target and with potential effects ranging from subtle to severely damaging.' Dauntingly the commander in chief also humors domestic targeting but specifies such theoretical operations cannot be carried out unless he has issued his consent or there is a national emergency, whereby various departments are authorized to act autonomously. Likewise the 18-page manuscript states cyberattacks are to conform to U.S. and international law unless they are overridden by presidential approval." Obama must have flipped. I bet he's still mad at Glenn!

The administration published some declassified talking points from the directive in January 2013, but those did not mention the stepping up of America's offensive capability and the drawing up of a target list.

Obama's move to establish a potentially aggressive cyber warfare doctrine will heighten fears over the increasing militarization of the internet.

The directive's publication comes as the president plans to confront his Chinese counterpart Xi Jinping at a summit in California on Friday over alleged Chinese attacks on western targets.

Even before the publication of the directive, Beijing had hit back against US criticism, with a senior official claiming to have "mountains of data" on American cyber-attacks he claimed were every bit as serious as those China was accused of having carried out against the US.

Presidential Policy Directive 20 defines OCEO as "operations and related programs or activities… conducted by or on behalf of the United States Government, in or through cyberspace, that are intended to enable or produce cyber effects outside United States government networks."

Asked about the stepping up of US offensive capabilities outlined in the directive, a senior administration official said: "Once humans develop the capacity to build boats, we build navies. Once you build airplanes, we build air forces."

The official added: "As a citizen, you expect your government to plan for scenarios. We're very interested in having a discussion with our international partners about what the appropriate boundaries are."

…The US is understood to have already participated in at least one major cyber attack, the use of the Stuxnet computer worm targeted on Iranian uranium enrichment centrifuges, the legality of which has been the subject of controversy. US reports citing high-level sources within the intelligence services said the US and Israel were responsible for the worm.

In the presidential directive, the criteria for offensive cyber operations in the directive is not limited to retaliatory action but vaguely framed as advancing "US national objectives around the world."

The revelation that the US is preparing a specific target list for offensive cyber-action is likely to reignite previously raised concerns of security researchers and academics, several of whom have warned that large-scale cyber operations could easily escalate into full-scale military conflict.

Sean Lawson, assistant professor in the department of communication at the University of Utah, argues: "When militarist cyber rhetoric results in use of offensive cyber attack it is likely that those attacks will escalate into physical, kinetic uses of force."

An intelligence source with extensive knowledge of the National Security Agency's systems told the Guardian the US complaints again China were hypocritical, because America had participated in offensive cyber operations and widespread hacking--breaking into foreign computer systems to mine information.

Provided anonymity to speak critically about classified practices, the source said: "We hack everyone everywhere. We like to make a distinction between us and the others. But we are in almost every country in the world."

The US likes to haul China before the international court of public opinion for "doing what we do every day," the source added.

One of the unclassified points released by the administration in January stated: "It is our policy that we shall undertake the least action necessary to mitigate threats and that we will prioritize network defense and law enforcement as preferred courses of action."

When Americans win something big-- like some kind of title or a ball game series or something like that, Obama calls them and congratulates them and sometimes invites them to the White House. Greenwald, like Obama, a constitutional lawyer (although not that much like Obama) was awarded the 2014 Pulitzer Prize for Public Service as well as the George Polk Award for National Security Reporting. No invitation to visit the White House… and not even a hacked phone call!