China con­fronts the mar­kets

Financial Mirror (Cyprus) - - FRONT PAGE -

China’s cur­rent eco­nomic woes have largely been viewed through a sin­gle lens: the gov­ern­ment’s fail­ure to let the mar­ket op­er­ate. But that per­spec­tive has led for­eign observers to mis­in­ter­pret some of this year’s most im­por­tant de­vel­op­ments in the for­eign-ex­change and stock mar­kets.

To be sure, Chi­nese author­i­ties do in­ter­vene strongly in var­i­ous ways. From 2004 to 2013, the Peo­ple’s Bank of China (PBOC) bought tril­lions of dol­lars in for­eign-ex­change re­serves, thereby pre­vent­ing the ren­minbi from ap­pre­ci­at­ing as much as it would have had it floated freely. More re­cently, the author­i­ties have been de­ploy­ing ev­ery piece of pol­icy ar­tillery they can muster in a vain at­tempt to mod­er­ate this sum­mer’s plunge in eq­uity prices.

But some im­por­tant de­vel­op­ments that for­eign­ers de­cry as the re­sult of gov­ern­ment in­ter­ven­tion are in fact the op­po­site.

Ex­hibit A is the Au­gust 11 de­val­u­a­tion of the ren­minbi against the dol­lar – a move that in­voked for US politi­cians the old adage, “Be care­ful what you wish for.” The de­val­u­a­tion – by a mere 3%, it should be noted – re­flected a change in PBOC pol­icy in­tended to give the mar­ket more in­flu­ence over the ex­change rate. Pre­vi­ously, the PBOC al­lowed the ren­minbi’s value to fluc­tu­ate each day within a 2% band, but did not rou­tinely al­low the move­ments to cu­mu­late from one day to the next. Now, each day’s clos­ing ex­change rate will in­flu­ence the fol­low­ing day’s rate, im­ply­ing ad­just­ment to­ward mar­ket lev­els.

The author­i­ties prob­a­bly would not have moved when they did had it not been for grow­ing mar­ket pres­sure for a de­pre­ci­a­tion that could help coun­ter­act weak­en­ing eco­nomic growth. In fact, bol­ster­ing growth might have been the pri­mary mo­ti­va­tion for the coun­try’s po­lit­i­cal lead­ers, even as the PBOC re­mained fo­cused on ad­vanc­ing the longer-term ob­jec­tive of strength­en­ing the mar­ket’s role in de­ter­min­ing the ex­change rate.

But the two mo­ti­va­tions are con­sis­tent: mar­ket forces would not be plac­ing down­ward pres­sure on the ren­minbi if China’s eco­nomic fun­da­men­tals did not war­rant it. The Amer­i­can politi­cians who de­manded that China float its cur­rency may have an­tic­i­pated a dif­fer­ent out­come – some­what un­rea­son­ably, given that mar­ket forces re­versed di­rec­tion in mid-2014 – but one can hardly blame the Chi­nese for tak­ing them at their word.

To be sure, China re­mains far from em­brac­ing a freefloat­ing cur­rency, let alone a fully con­vert­ible one, which would re­quire fur­ther lib­er­al­i­sa­tion of con­trols on cross­bor­der fi­nan­cial flows. Uni­fi­ca­tion of on­shore and off­shore mar­kets is more im­por­tant than a float­ing ex­change rate in de­ter­min­ing whether the In­ter­na­tional Mon­e­tary Fund will in­clude the ren­minbi in the bas­ket of cur­ren­cies used to de­ter­mine the value of its re­serve as­set, the Spe­cial Draw­ing Right. Much com­men­tary on the sub­ject has un­der­es­ti­mated the im­por­tance of the cri­te­rion that the cur­rency be “freely us­able.”

Nonethe­less, many are fret­ting that China’s ex­change-rate ad­just­ment has trig­gered a “cur­rency war,” with other emerg­ing economies de­valu­ing as well. But, more than a year af­ter the eco­nomic fun­da­men­tals swung against emerg­ing mar­kets (and es­pe­cially away from com­modi­ties) and to­ward the United States, this ad­just­ment was due. Though the Chi­nese move likely in­flu­enced the tim­ing, other de­val­u­a­tions would have in­evitably taken place. Warn­ings about com­pet­i­tive de­val­u­a­tions are mis­lead­ing.

Ex­hibit B in the case against at­tribut­ing fi­nan­cial de­vel­op­ments in China to gov­ern­ment in­ter­ven­tion is the stock-mar­ket bub­ble that cul­mi­nated in June. Ac­cord­ing to the con­ven­tional wis­dom, the author­i­ties con­sis­tently in­ter­vened not only to try to boost the mar­ket af­ter the col­lapse, but also dur­ing its year-long run-up, when the Shang­hai Stock Ex­change com­pos­ite in­dex more than dou­bled. The fin­ger-wag­ging im­pli­ca­tion is that Chi­nese pol­i­cy­mak­ers, par­tic­u­larly the stock-mar­ket reg­u­la­tor, have only them­selves to blame for the bub­ble.

There is un­doubt­edly some truth to this story. It seems clear that the ex­tra­or­di­nary run-up in eq­uity prices was fu­eled by a surge in mar­gin fi­nanc­ing of stock pur­chases, which was le­galised in 2010-2011 and en­cour­aged by the PBOC’s mon­e­tary eas­ing since last Novem­ber. Like­wise, there was plenty of sup­port for the bull mar­ket in gov­ern­ment-spon­sored news media, for ex­am­ple.

But what many com­men­ta­tors fail to note is that China’s reg­u­la­tory author­i­ties took ac­tion to try to dampen prices over the last six months of the run-up. They tight­ened mar­gin re­quire­ments in Jan­uary, and again in April, when they also fa­cil­i­tated short-selling by ex­pand­ing the num­ber of el­i­gi­ble stocks. The event that ul­ti­mately seems to have pricked the bub­ble was the China Se­cu­ri­ties Reg­u­la­tory Com­mis­sion’s June 12 an­nounce­ment of plans to limit the amount that bro­ker­ages could lend for stock trad­ing.

This is pre­cisely the kind of counter-cycli­cal macro­pru­den­tial pol­icy that econ­o­mists of­ten rec­om­mend. But, whereas ad­vanced economies rarely im­ple­ment this ad­vice, China and many other de­vel­op­ing coun­tries do tend to ad­just reg­u­la­tion, in­clud­ing re­serve re­quire­ments for banks and ceil­ings on home­buy­ers’ bor­row­ing, coun­ter­cycli­cally.

One could crit­i­cise the Chi­nese reg­u­la­tor on the grounds that the ef­fect of its moves to in­crease mar­gin re­quire­ments did not last long; or one could crit­i­cise it on the grounds that its moves caused the re­cent crash. But, ei­ther way, these mea­sures were in­tended to stem the rise in mar­ket prices, rather than to con­trib­ute to it.

This is not a triv­ial point. Nor is the fact that the PBOC’s in­ter­ven­tions in the for­eign-ex­change mar­ket over the last year have aimed to dampen the ren­minbi’s de­pre­ci­a­tion, not add to it. Given this, it is facile to blame China’s prob­lems on gov­ern­ment in­ter­ven­tion.

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