Thursday, August 27, 2015

China now knows what goes up must come down.The death of China’s bull market is a sobering wake-up call for the princelings of the Politbureau

The death of China’s bull market is a sobering wake-up call for the princelings of the Politbureau. Overconfidence on the part of Chinese leaders has contributed to the financial chaos on the Chinese sharemarket.

The origins of this week's global financial chaos – and the economic storm clouds now darkening over Australia – are best illuminated by a strange sequence of events that may or may not have taken place three months ago. "It's good to trade shares," China's President Xi Jinping reportedly told a journalist, during an inspection tour in Hangzhou. The Shanghai Index "will soon hit 10,000 points!"

Xi was reportedly bantering with a reporter who had jokingly confessed that she had joined the national pre-occupation of "stir frying" shares. At first, when the exchange was circulated by another journalist on her Wechat microblog, with Xi using the same metaphor for flipping over-heated shares, China's army of investors ignored it or dismissed it as fake.

Some [Chinese leaders], it seems, believed they could suspend the laws of economics. 

China's bull market (or "mad cow" market to use literal Chinese) had already worked itself into a frenzy, with the Shanghai Composite Index sitting just shy of 5000 points after doubling in just six months. Why would China's strongman leader bet his reputation by predicting that this mad cow market would quickly double again?

But two days later when the market hit an air-pocket, on May 28, China's hyperactive censors allowed the exchange to go viral across the Chinese cyber sphere and also to be reported by mainstream online news portals. Xi's utterances, apocryphal or otherwise, became known as "The Ten Thousand Points Discussion" and they were given a whole new layer of meaning.

The implicit endorsement of propaganda officials was understood to be some kind of official financial guarantee. And so investors gave the index one last great push until it reached a peak of 5166 points, on June 12 – a stratospheric level that not even the Chinese Communist Party could sustain.

When the market inevitably collapsed the party battled to save the credibility of its leader and itself by deploying its unrivalled array of command-economy resources to prop it up again. For seven straight weeks it forced brokers to buy, banned major shareholders from selling and threatened great police enforcement actions against "manipulators" seen to be doing the wrong thing. Analysts estimated the state spent several trillion yuan trying to defy economic gravity, before raising the white flag this week. At the same time, officials picked another fight with economic gravity, by mishandling a currency adjustment and triggering new waves of capital flight.

These events conspired this week to generate the greatest burst of financial volatility that the world has seen in several years.

The last time the world experienced financial and share market volatility like this was during the depths of the Global Financial Crisis in 2008. Back then, China's extraordinary fiscal and monetary stimulus stabilised the world economy and rescued Australia from the brink of what might otherwise have been a deep recession. This time, not only have we discovered that the Chinese economy is in some trouble but, for the first time in nearly two decades, the credibility of Chinese leaders has been damaged and it's not clear that they know how the problems will be fixed.

In a research note to multinational chief executives on Wednesday, the Conference Board, a respected US non-profit economic research group, said: "The regional and global equity contagion experienced over the past two days is primarily about the world waking up to the China reality."

"Growth is much lower than official statistics indicate and the authorities' ability to manage growth is far more limited than previously thought," it said.

Beijing's mega-stimulus in 2008 set off the greatest construction boom the world has ever seen. By 2011, China's decade of hyper-industrialisation had boosted Australia' national income by 13 per cent, according to a Reserve Bank analysis. We all received far higher incomes, bought more things, and watched our house prices soar without having to exert more effort.

But delivering the world's largest ever fiscal and monetary stimulus also did China a lot of damage. It fuelled a credit boom and a series of rolling asset booms that rivalled anything that Japan or the United States have ever seen.

It undid years of effort to reform state-controlled enterprises and discipline credit and capital markets. Corruption grew out of control. All these costs were clearly foreseen and articulated by Chinese technocrats at the time.

Perhaps the greatest damage that flowed from the GFC mega-stimulus is what it did to China's political establishment. The sudden surge in China's relative fortunes encouraged many Chinese leaders to take their Marxist-Leninist-Stalinist-Maoist ideology more seriously. Some of them, particularly many in the "princeling" cohort, began to talk and act as if they had proven the superiority of their system and perhaps also of themselves. Some of them, it seems, believed they could suspend the laws of economics.

Most investors knew that China's "miracle growth stage" finished some time ago. Neither China's deepening economic travails nor individual company fundamentals had ever really figured in the investment equation.

But it was only after a March Politburo meeting that the realms of propaganda and economic reality were seriously blurred and the party took to being the cheer-leader-in-chief. After April 1, when the party's self-described "mouthpiece", The People's Daily, printed a series of editorials that virtually guaranteed that punters could not lose, the share market rose another 25 per cent in just eight weeks.

When Xi's Ten Thousand Points Theory was allowed to exist online, trading on this apparent political guarantee made rational sense as China's leaders had policy credibility. Now, after bizarre state-backed efforts to fuel a stock market bubble and stop it from bursting, the policy credibility has been squandered and the bill is falling due.

"The sheer volume of the capital involved and the consequences that may follow over a long period demand that we seriously reflect on what was done and what should have been learned," said a commentary in Caixin Magazine.

It's the end of an extraordinary era for Australia, too. The Chinese tailwind that inflated our living standards for a decade is now blowing the other way.

John Garnaut is Fairfax Media's Asia-Pacific editor. Illustration: Andrew Dyson

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