Pan­icked mar­kets need a time­out

The Pak Banker - - OPINION - Wil­liam Pe­sek

On the way to re­mak­ing China's econ­omy, Pres­i­dent Xi Jin­ping has hit many road­blocks: vested in­ter­ests, a change-averse Com­mu­nist Party, lo­cal of­fi­cials ac­cus­tomed to the sta­tus quo. Who knew the real bar­rier would be for­eign in­vestors?

For years, the world has called on China to loosen its grip on the yuan, drop its ar­bi­trary growth tar­gets, al­low stocks to fall, at­tack cor­rup­tion and let reck­less bor­row­ers suf­fer losses. But when­ever Bei­jing has taken any of these steps, global in­vestors have re­sponded with fear and trem­bling.

Wall Street's sud­den turn for the worse doesn't have any­thing to do with China's eco­nomic fun­da­men­tals. News emerged last Fri­day that China's man­u­fac­tur­ing ac­tiv­ity had fallen to a six-year low -- but that was en­tirely con­sis­tent with reams of re­cent data show­ing weak in­dus­trial pro­duc­tion, re­tail sales, in­fla­tion and rental rates. In­vestors can't be shocked to hear that China's 7 per­cent growth rate in the first six months of 2015 was the slow­est in six years.

The real trig­ger for mar­ket tur­moil was China's Aug. 11 de­val­u­a­tion. But China shouldn't be blamed for in­vestors' hyp­o­crit­i­cal re­sponse. A more mar­ket-de­ter­mined ex­change rate had long topped the China wish list of ev­ery­one from U.S. Pres­i­dent Barack Obama to the In­ter­na­tional Mon­e­tary Fund to Lon­don hedge funds. When China obliged, mar­kets suc­cumbed to panic. The same goes for China's re­cent de­ci­sion to al­low mar­ket forces to drive down the Shang­hai Com­pos­ite In­dex (down a com­bined 15 per­cent Mon­day and Tues­day).

It's true that China is a pretty dis­mal com­mu­ni­ca­tor. "Mar­kets," says economist Arthur Kroe­ber of GaveKal Drago­nomics, "trade as much on pol­icy sig­nals as on eco­nomic re­al­ity, and there has clearly been a break­down of com­mu­ni­ca­tion be­tween Bei­jing and the rest of the world." But it was still clear enough that Bei­jing's pol­icy mak­ers weren't re­ally pan­ick­ing -- if they were, their 3.1 per­cent de­val­u­a­tion would've been closer to Kaza­khstan's re­cent 20 per­cent drop.

China's slow­down has been the most tele­graphed by any ma­jor econ­omy in decades. But as soon as Xi seemed sin­cere about mak­ing good on his rhetoric about a "new nor­mal" and mar­kets play­ing a "decisive role" in the econ­omy, in­vestors screamed for him to stop. Mar­kets are send­ing a clear mes­sage to Xi's gov­ern­ment: More growth, less of this messy re­form stuff.

In­vestors' aban­don­ment of nu­ance has left China in a bind. China's ob­ses­sion with global clout has been driv­ing its ef­fort to get the yuan counted among the IMF's five re­serve cur­ren­cies. Xi's pri­or­ity for the next 12 months can be summed up with three words: sta­bil­ity, sta­bil­ity, sta­bil­ity. So we shouldn't be shocked if China re­sponds to the re­cent mar­ket tur­moil by shelv­ing its re­form ef­forts and clamp­ing down more on the public's per­sonal free­doms.

"What is in­creas­ingly ap­par­ent is that China's lead­ers want the eco­nomic growth that cap­i­tal­ism pro­duces, but with­out the down­turns that come with it," writes Richard Haass, pres­i­dent of the Coun­cil on For­eign Re­la­tions in a Pro­ject Syn­di­cate op-ed. "They want the in­no­va­tion that an open so­ci­ety gen­er­ates, but with­out the in­tel­lec­tual free­dom that de­fines it. Some­thing has to give."

With the ver­tig­i­nous plunge in Shang­hai shares and "Chi­nese cri­sis" head­lines span­ning the globe, Bei­jing has seen what hap­pens when it cedes con­trol to mar­kets. It's telling that China waited un­til Tues­day -- af­ter it had al­ready been blamed for crash­ing global mar­kets -- to cut in­ter­est rates (for a fifth time since Novem­ber) and re­lax banks' re­serve re­quire­ments.

By stag­ing tantrums at the first sign of re­form, in­vestors are mak­ing it more dif­fi­cult for Bei­jing to take steps to­ward be­com­ing a more sus­tain­able econ­omy. In­vestors should stop treat­ing China like a gar­gan­tuan, 1.3 bil­lion-em­ployee com­pany with a duty to con­stantly sur­prise to the up­side, and start show­ing a more nu­anced ap­pre­ci­a­tion for China's sit­u­a­tion.

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