China’s Shortest Day Will Prolong the Pain
By dragging out the pain of its stock- and currency-market adjustments, China is only ensuring that things will get worse before they get better.
Chinese stocks had just about the shortest trading session possible Thursday morning, thanks to a tempest set off by China’s own depreciating currency. Within half an hour of opening, the CSI 300, a blue-chip index, was down 7%, triggering “circuit breakers” that halted trading for the day.
This
system has been in place for less than a week, but it isn’t too early to judge it a failure. Indeed, authorities announced late Thursday that they would suspend its usage. The circuit breakers incentivize traders to unload shares immediately once a selloff starts, to beat the market shutdown. That trading was halted completely by 10 a.m. also made it impossible for equities to recover any ground, as they well might have once the People’s Bank of China intervened to support the currency.
The fundamental problem is that Chinese stocks and its currency are both overvalued, and Beijing is afraid to let them adjust. Shanghai-traded shares are still above their historical valuations, and
at a big premium to virtually identical shares in Hong Kong.
During last summer’s meltdown, China’s securities regulator banned shareholders who own 5% or more of a company from selling any of their holdings for six months. It doesn’t take a market genius to recognize that as Friday’s scheduled expiration of the ban approached, traders might get nervous.
So on Thursday, the regulator doubled down on its mistake, albeit with some adjustments. Over the next three months, those big shareholders will be allowed to sell up to a 1% stake—though only with a punitive 15 days’ notice. This will merely delay the ultimate reckoning, and keep an overhang of frozen shares over the market.
For the currency too, the obvious market direction is down, at least against the dollar. China’s monetary policy likely needs more loosening, while the U.S. is set to keep raising rates. The dollar is also strong against the currencies of China’s major trading partners.
A
currency basket unveiled in December may have become the government’s yuan-weakening benchmark—a statement posted on the central bank website Thursday pointed out that the currency was basically stable against the basket last year. But it remains unclear how closely China intends to track it.
All things being equal, a cheaper currency should be welcome news for China. After all, owners of European and Japanese equities cheer whenever currencies there fall. But there is a difference between an ordinary decline in a market-based currency and a managed decline in a government-controlled exchange rate like China’s.
Facing depreciation pressure, China seems to have two choices: Allow the currency to fall to a market-determined level all at once or go for a slow devaluation.
But given that the disruptions a rapid fall would cause—to unprepared global markets, diplomatic relations with the West and Chinese companies with unhedged, dollar-denominated debt—it really has only one.
The go-slow strategy has costs of its own, though. Repeated interventions drain currency reserves, which fell by more than $100 billion in December. Using foreign currency to buy up yuan also shrinks the domestic money supply, counteracting stimulus efforts. What’s more, a slow-motion devaluation creates a one-way bet against the currency, giving market players an incentive to pull money out of China sooner rather than later.
Transitioning from a crawling peg to a freer exchange rate was never going to be easy, but Beijing should have made the move years ago. Waiting until now just forced it to act against a backdrop of slowing growth and a deflating equity bubble.
The impression left on investors is that Chinese authorities are out of their depth. Certainly with respect to the stock market, their reputation for incompetence is well-earned. This collapse in confidence will make it harder still for China to engineer a turnaround.
China’s Shortest Day Will Prolong the Pain - WSJ
