China stock market crash: All you wanted to know in 4 points

29 Aug 2015 | Author: | No comments yet »

Can Xi Jinping Ride China’s Market Dragon?.

After a dizzying two weeks that saw a rapid plunge and rebound in equity prices, investors are looking forward to a week of economic data that may provide clarity on the likelihood of a near-term US interest rate hike and help tamp down the market’s recent wild swings.Global stock markets surged Thursday on renewed confidence in the US recovery after days of wild swings, but some observers warned of more turbulence to come over the slowing Chinese economy.Since taking China’s top job three years ago, Xi Jinping and his administration have cloaked themselves in the mantra of “the Chinese Dream,” a feel-good mix of national rejuvenation and ever-higher standards of living. Buyers streamed back to markets after Shanghai, the epicenter of the volatility, snapped a five-day losing streak, and a surprisingly strong new estimate of US economic growth in the second quarter — 3.7 percent — gave more support as the day passed.

Back in April, state-run media encouraged ordinary Chinese and companies to grab their share of that dream by buying stocks—even though China’s economic growth already was known to be slowing. Car sales, construction spending, the Federal Reserve’s “beige book” and jobs growth may show the economy is strong enough to withstand the first rate hike in nearly a decade from the Federal Reserve, despite worries about a hard landing for China’s economy. That — and a production stoppage by Shell in Nigeria — sent oil prices zooming up 10 percent, their biggest single-day jump since the 2009 global economic crisis. “The US economy continues to perform on a consistent basis… (showing) that its economic recovery is sustainable… The United States is leading the global economy as it has been since late last year,” said FXTM chief market analyst Jameel Ahmad.

The equities “surge” became so tied to the China Dream that people called it “Xi’s stock boom.” Then came a white-knuckle roller-coaster ride. These dramatic falls, which followed a more gradual but still stomach-churning 11.5pc decline in Chinese stocks the week before, ripped through global markets.

Global stock markets were stung by severe swings in recent weeks, stoked by concerns that a slowdown in China’s economy may be more harsh than anticipated. After peaking in mid-June, the Shanghai Composite Index plunged nearly a third in less than a month—then rallied temporarily following government bail-out measures. America’s Dow Jones Industrial Average share index plummeted an unprecedented 1,000 points, before closing 588 down – its biggest decline for four years. But after confirming a move into correction territory, the S&P 500 rebounded to score its best two-day percentage gain in over six years this week, as comments from Fed officials led some investors to believe the market turmoil and global growth concerns had diminished the possibility of a rate hike at the central bank’s September meeting. The moves by the Chinese government are “not as effective as they used to be,” said Yale University finance professor Chen Zhiwu on a conference call with the Council on Foreign Relations.

The Bundesbank, Germany’s central bank, estimates that Germany’s gross domestic product will be about 0.3 percentage points lower if real domestic demand in China is 9 per cent lower than expected within the next two years. Fed Vice President Stanley Fischer told CNBC during the Fed’s annual conference in Jackson Hole, Wyoming, that the committee was “heading in the direction” of higher rates. The turnaround in Chinese shares, which ended with a 5.34 percent gain, came in the last hour of trade Wednesday, sparking speculation of state-engineered buying and talk of more possible support measures from the government. “There were external funds flowing in, but it’s uncertain if it was the national team,” Shenwan Hongyuan analyst Gui Haoming said, referring to entities which trade on behalf of the government.

Traders in futures markets that bet on rate increases boosted September’s odds after his words. “There is a narrative out there that Yellen’s Fed is looking for a reason to delay the rate hike; I don’t think that is necessarily the case,” said Brad McMillan, chief investment officer for Commonwealth Financial in Waltham, Massachusetts. Such market gyrations have, more than at any time since the Lehman Brothers collapse in September 2008, raised fears of a renewed financial crisis, with all the related economic, political – and human – fall-out. State media recently has hinted at significant opposition to Xi’s economic ambitions—especially the reform of China’s ponderous state-owned enterprises—and alarm that his team’s crowded agenda may have distracted focus from China’s worrisome economic slowdown.

Even though €75-billion ($111-billion) in exports to China make up less than 7 per cent of Germany’s total exports, Germany would not have survived the financial crisis relatively unscathed if not for China’s hugely dynamic economy. In a commentary that raised many eyebrows, various state media, including the website of the state-run broadcaster CCTV, recently criticized the “stubbornness, ferocity, complexity and weirdness of those who haven’t adapted to reform or are even opposed to reform.” It stated that the opposition “may go beyond what people imagine.” Yet even Xi, who since 2012 has consolidated his authority more swiftly than any other Chinese leader since the Great Helmsman Mao Zedong, could be in trouble if he’s no longer able to deliver the tradeoff that China’s mandarins have mastered for decades: fast growth in exchange for curtailed freedoms. Thomson Reuters data shows third-quarter earnings expectations have dropped 6.4 percent for the industrial sector and 8.8 percent for the materials sector since July 1. While cutting interest rates for the fifth time in nine months, Beijing also tightened rules on short-selling, banned large shareholders from offloading stakes and forced local pension funds into domestic stocks. Should analysts continue to downgrade their expectations for third- and fourth-quarter earnings in those sectors or more broadly, that could make stocks more expensive, even after the recent selloff. “It is more important to the US whether or not GM and Ford can sell cars there,” said Kim Forrest, senior equity research analyst, Fort Pitt Capital Group in Pittsburgh.

We just have to play them right.” Fed Chair Janet Yellen is not attending, but her deputy, Stanley Fischer, will make keynote remarks on Saturday that could point to whether the central bank believes the global turmoil is severe enough to hold off on a long-expected hike in interest rates. On Wednesday New York Federal Reserve head William Dudley, seen as close to Yellen and Fischer in his thinking, said that the Chinese turmoil had made the arguments for a rate rise in September “less compelling.” But Michael Taylor, head of British investment adviser Coldwater Economics, said that the global fall in prices, especially of key commodities like oil, will turn into a pickup in global demand over the next half year. “I think just the uncertainty will keep the Fed on hold, even though monetary conditions are turning up, and you should expect global demand to pick up with it over the coming six months,” he said.

Earlier this year, when Chinese stocks reached frenzied heights, communist party censors further tightened their monitoring of media and internet content by instructing editors to not “exaggerate panic or sadness. The reversal on Western markets, meanwhile, was largely driven by a senior Federal Reserve official hinting that an interest rate rise, previously signalled for September, is now “less compelling” given renewed financial volatility. A similar sentiment has spread to the UK, with investors betting the Bank of England won’t raise rates until October 2016 – six months later than expected just a few weeks ago. And the greater the worries about China, the less likely it is that Western central banks will be prepared to normalize monetary policies – much to the disappointment of insurers.

There is also now rampant speculation, which the Fed isn’t discouraging, that America will soon engage in yet another round of quantitative easing – so-called QE4. He’s grabbed the reins of a lot of economy policies—usually the responsibility of the prime minister—and heads a raft of smaller decision-making groups in charge of everything from foreign relations to the upcoming 70th anniversary parade celebrating victory over Japan in WWII. And in a move redolent of Maoist times, Xi has granted a special pardon allowing for the early release of a number of convicted criminals as part of the anniversary commemoration. The Western world is similarly engaging in gross market distortion, albeit of a different kind – by keeping real interest rates firmly in negative territory and, once again, desperately stoking shares with the promise of further hundreds of billions of dollars of virtually printed money. For many Chinese, playing the stockmarket is tantamount to gambling in a casino, because of a lack of transparency, rule of law and adequate regulation.

Having grown 9.8pc a year since the late-1970s, the economy of the People’s Republic now outstrips that of America on a purchasing power parity basis (adjusted for living standards). In recent months, growth has slowed – with official forecasts pointing to a 6pc to 7pc expansion in 2015 and some analysts questioning the veracity of government statistics. The concept of a “state-mandated bull market” is dangerous, unsustainable and “naïve,” declared Caixin, a prominent financial publication, “it can easily become a ‘mad cow,’ spiking up and down.” New investors—many of whom nevergraduated from high school—were shocked to discover the hard way that officialdom won’t always ride to their rescue. “I don’t believe in government bailouts anymore,” said a 20-something Beijing woman who requested anonymity because she feared she might be punished for expressing such doubts, “Now there’s a big rumor that after the military parade on Sept. 3, all such bail-outs will stop.

To counter this, the government hopes to boost private consumption – which leads to an increase in salaries and wage costs – and reduce the competitiveness of exports, the second pillar of the Chinese model. Last week Prime Minister LiKeqiang repeated assurances that China’s 2015 growth target of around seven percent—the lowest in decades—was doable. The stock market remains some 40pc down since June – and China’s banks have a swath of non-performing loans smouldering on their balance sheets, after years of over-investment in projects driven by political rather than economic logic. This worrying mix has underscored questions as to whether Xi’s team can manage a soft landing, especially since it hopes to restructure the economy to rely more on domestic consumption.

Having said that, China’s property market, which drives economic sentiment to a greater extent than equities and underpins the banking sector, remains buoyant. Beijing has outlined its aims to wean the economy away from dependence on state-directed investments, to liberalize financial markets, and to allow market forces a more “decisive” role in the economy. However China’s recent stock market tumult has triggered aggressive governmentinterventions—including a freeze on IPOs and instructions for big players to buy stock—that run counter to those aims. When asked if instituting reforms during this economic slowdown would be painful, Prime Minister Li said the challenges were growing more acute, not just like “clipping one’s toenails, but more like taking a knife [to one’s own flesh].” Meanwhile, Xi’s anti-corruption campaign aimed at snagging both “tigers” and “flies”—both senior and working-level officials, respectively—has been so aggressive that many fearful apparatchiks have adopted a risk-averse strategy of bureaucratic paralysis. Among the prominent “tigers” nabbed so far, Xi’s graft-busters have toppled Ling Jihua, former chief of staff to Xi’s predecessor Hu Jintao; two senior generals; and the former security czar Zhou Yongkang.

Some have quietly urged Xi’s team to focus more intently on the economic slowdown, rather than get sidetracked with the anti-corruption manhunt, according to a recent New York Times article. No Western politician would have been considered capable of making planned interventions in economic affairs while constantly increasing prosperity and avoiding crises. The scandalous purge of Ling Jihua reflected most negatively on Ling’s mentor Hu Jintao, Xi’s immediat epredecessor as president and party head. (One of the first public hints that Ling was living beyond his means was a spectacular car crash that killed his son, who was driving a black Ferrari in the company of two young semi-naked women at the time.) But a more senior rival to Xi’s authority is believed to be Hu’s predecessor, Jiang Zemin, who was party head from 1989 to 2002 and continues to win respect as the dean of a “Shanghai faction” of leaders, despite his advancing age and uncertain health. In 1998, an emerging markets crisis, starting in Thailand and then spreading across Asia to Russia, was indeed the catalyst for a significant downturn on global markets.

Rumors whirled through Chinese social media after a stele adorned with Jiang’s calligraphy, which used to enjoy a prominent position at the party’s prestigious Central Party School in Beijing, was removed August 21. No doubt this was due to China’s vast currency reserves of more than $3-trillion (U.S.), which could be used in an emergency, and to its long success story.

The collapse derived from chronic private and public sector indebtedness across such countries, many of which were in the throes of emerging from years of economic isolation. The incident triggered speculation on social media—“why don’t they explain the reason for ‘the removal’?…There are games behind this! —and humorous references to “the toad,” a nickname for Jiang because of his prominent stomach and over-sized spectacles. Less than two weeks before the stele’s disappearance, an unusual editorial in the party mouthpiece People’s Daily warned that retired leaders should avoid the political arena and “cool off” like a cup of tea after a guest has departed. It accused “some leading cadres” of creating a “quandary” for new leaders, “fettering their hands from doingbold work.” The reference is widely interpreted to mean Jiang, though he was never named.

On the other hand, it intervenes – as we have seen with the devaluation of the yuan or the collapse in stock prices – while showing that it does not always have the golden touch. Instead, the People’s Daily indicated that former security honcho Zhou Yongkang had bucked the “norm for officials to relinquish power after retirement.” Once a member of the all-powerful Politburo Standing Committee, Zhou is China’s most senior communist party official to be convicted of corruption—and was rumored to have plotted against Xi. If we are on the brink of another “Lehman moment”, then it is the West’s response to the sub-prime crisis – above all, our continued reliance on growing debt and monetary stimulus – that must take a large share of the blame. Then there is the dark shadow that has long been cast over global markets by the potential unravelling of the grossly incoherent grand project that is Europe’s single currency.

While popular among liberal-minded Chinese, he’s seen as China’s weakest prime minister in decades because Xi has concentrated so much decision-making power into his own hands. “[If Xi] really needs a scapegoat, then Li fits the bill,” says Willy Wo-LapLam, a sinologist at the Chinese University of Hong Kong. In part, to demonstrate to the International Monetary Fund enough flexibility that Washington might deign to allow the yuan to be included in the official reserve currency basket. Meanwhile, lower-level figures are already being questioned and detained in media, banking and regulatory organs for possible illegal stock-trading and rumormongering. This week China’s central bank lowered the benchmark lending and deposit rates by 0.25 percentage point and cut the reserve requirement ratio (the amount of cash banks are required to holdin reserve) by 0.5 of a percentage point. The latter move would help boost bank lending by injecting about RMB 650 billion ($100 billion) into the system, said Liu Li-gang, chief China economist at the Australia and New Zealand BankingGroup in a note Tuesday. (But he said further monetary policy easing would likely be needed for Beijing to hit its seven percent growth target.) Additional measures could include more infrastructure investment (though of course this would hardly help encourage domestic consumption in the long run), new budget or tax policies and political moves geared towards restoring confidence.

He’s called up an unusual military parade for Sept. 3 to mark the 70th anniversary of Japan’s defeat, and for the first time Beijing has invited foreign troops to take part. Carefully orchestrated images of Xi hailing the People’s Liberation Army honor guard, and hobnobbing with American president Barack Obama may stoke feelings of national pride among many Chinese. For example Republican frontrunner Donald Trump has publicly suggested that Xi should betreated to “a Big Mac” instead of a state dinner at the White House, because Beijing has “sucked jobs…and all the money right out of our country.” If Xi’s image as a decisive world leader is sullied by perceived diplomatic slights, however minor, his critics back home will feel even more emboldened. Chinese may love aparade, but many are veteran cynics. “The big parade is useless,” groused one microblogger this week. “There are many more Chinese in poverty than there arein the parade. Moreover your real strength may not be that great anyway.” Another dismissed the spectacle as a “goose-stepping performance meant to entertain the leaders…Can they really fight a war?

But as the drama of recent weeks has shown, this double-barrelled challenge seems more complex than Xi’s team expected. “Reform has to address the politics and economy simultaneously,” insists Beijing-based political analyst Zhang Lifan, “If the political system doesn’t change, bureaucratic inertia will just send the reforms around in circles.” That may sound familiar to Xi—and he still clearly faces a long, hard journey ahead, before he can achieve his Chinese Dream.

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