Investors will take their ball and leave
The BBC reports that the stock markets of China and Hong Kong have lost $6-trillion in value since their recent highs. That’s just not good enough for the China Securities Regulatory Commission and something had to be done.
President Xi Jinping has tightened regulation of the stock market by, in particular, introducing limits on “short selling”. I doubt he’d be as enthusiastic about introducing limits on “long buying”, or simply investing in shares, both of which push prices up. As ever, price is determined where supply meets demand, and for every seller there must be a buyer, so why interfere?
The situation is slightly different here, and the new limits will apply only to short selling selling shares you do not own, which someone has to lend you, in the hope that their price will go down and you can buy them back at the lower price and lock in a profit. The lenders earn interest on the loan, and you make a profit (if the price drops). There is risk on both sides of the deal, so why don’t we just let the market sort it out?
The China sell-off has a real underlying rationale as economic growth rates are expected to slow, but we can’t ignore that the previous high rates of growth may also have been a result of government involvement.
Here’s the conundrum: can you mix market and government forces into some sort of sustainable equilibrium, or is a regulated free market just an oxymoron? Over the long term, capital with discretion will shy away from regulatory interference and even excessive red tape, and these investment destinations are eventually shunned, or the risk of regulatory impacts is factored into the cost of capital, finally making it prohibitive.
A case can be made (a case that is at least partially well founded) that the regulatory authorities have a responsibility to protect “innocent” market participants (though this does beg a definition of “innocent”).
Forcing people to behave in a certain way, or prohibiting them from behaving in another way, will only get you so far before the carrots and sticks come into play (with obvious exceptions, such as crime, where force may be the only way to keep law and order and overcome the consequences of vice).
There is, however, a limit to how much you can force people to work for government’s purpose without them sharing in the fruits of that labour ask China. Incentives are better at creating broad-based common purpose than any form of artificial imposition will ever be.
If there is a level playing field, with equal access to investment opportunities and information right down to the individual level, the less interference the better. Overprotection can eliminate the learning curves embedded in the formative stages of proper investment process. As we limit choice or put boundaries around individual market participants’ behaviour we create artificial value indicators and other unintended consequences, which inevitably lead to higher concentrations of economic power and central control.
If one particular country (or market jurisdiction) doesn’t “play fair” then it will either lose its right to play (capital will leave) or it will encourage other markets to do likewise and we’ll end up with situations like we’ve seen in the currency markets, where the interest rate policy in a major central bank almost requires all lesser central banks to follow suit (to remain competitive in crossborder trade). This leads to a result not much different from where we started before the race to the drain began, which was then based on economic realities not committee consensus.
It seems clear to me, over long-term investment horizons, that the less intervention the better and the more you make your own rules the more you should expect to end up playing with just yourself, which doesn’t produce anything and isn’t much fun.