Wednesday, August 26, 2015

For CCP, Stock Market Meltdown Takeaway Isn’t “Interference is Bad”; It’s “Why Didn’t Interference Work?”

I suppose much of the journo commentariat was born since 2008 and therefore has no memory of TARP, Too Big To Fail, or Jamie Dimon rolling around naked inside a gigantic vat of taxpayer money, so there has been a considerable amount of handwring about how the CCP defiled the purity of the stock market by flinging a trillion or so RMB at the markets in a faltering attempt to moderate the collapse of share prices on the Shanghai exchange.

“Purity of the stock market”.  Chew on that a while.

I expect the poohbahs of Zhongnanhai are more concerned with the interesting question of why a few phone calls and a trillion RMB were unable to stem the decline in a neat, orderly way, and it turned out the best way to handle the rout was to stand back and let the stock market crater.

And, no, I don’t think the red emperors’ conclusion is “markets are awesome and all-powerful and the CCP must accept its new role as humble handmaiden to high finance”.

Here’s a few observations/interpretations.

1.  The bubble had to pop.  Valuations were at ridiculous P:E levels of 60 to 80 and the optimistic "Silk Road Will Save Us" narrative that was supposed to prop up equities and ease the transition to the "New Normal" of lower growth wasn't holding up for international or, I imagine, knowledgeable domestic investors.

2.       I think history will judge that the bubble was fueled not only by gullible small-time investors, but an ocean of money brought in by the carry trade (borrowing cheap dollars to convert into RMB to chase high returns in the PRC stock market).  Somewhere I read that a trillion dollars of carry trade money might have made its way into the market.  That’s serious money.

3.       In my opinion, the PRC situation looks a lot like Japan in the 1990s.  Banks with underperforming/nonperforming policy/infrastructure loans looked to boost their bottom lines through carry trade, investment vehicle, and stock trading shenanigans.

4.       A lot of money, smart and otherwise, came into the market through unconventional funds, margin accounts, and whatnot.

5.       The whole stock market spectacle from April to July looks like a classic pump-and-dump, with big money investors levering up to boost the bubble and sucking in fish/sheep to be shorn/sacrificial lambs or whatever hapless animal metaphor you want to call the retail investors whose primary function, as always, was to get stuck with the funny paper at the end of the day.

6.       When the slide began, in the best time-honored fashion priority was given to make sure that the big money boys and girls dodged their margin calls and got closed out of the market at acceptable levels.  The fact that the top securities companies were entrusted with executing the bailout probably didn’t hurt their buddies one bit.

7.       The CCP wanted and expected the bubble to pop in an elegantly authoritarian and orderly fashion.  When it didn’t, the leadership bought the idea that a disorderly decline was undesirable, mainly because a spectacularly craptacular market would be unable to handle the new share offerings intended to wean the SOEs from their leech-like dependence on the banking system for ridiculously cheap capital.  So we got the panicky money-shoveling, the trading bans, and orders to security companies not to sell their own book.

8.       But instead of orderly, they got spectacularly craptacular.  That POs the CCP.

9.       What I expect concerns the CCP is the suspicion that market control efforts were balked by a lot of things: not just market forces, but also poorly monitored and regulated capital inflows, and by self-dealing shenanigans by the securities companies that were charged with executing the bailout.

10.   So now it’s time to suppress the forces that interfere with CCP-mandated market operations.  Limit margin, limit short sales, crack down on the unconventional finance companies a.k.a. hedge funds with Chinese characteristics, and hammer a few security firm execs.

11.   I expect there is a genuine split within the CCP between liberal reformers a.k.a. believers in the inevitability of oligarchical market-driven growth & Xi Jinping’s emphasis on controlling and channeling market and economic forces to buttress CCP dominance.  Xi’s aura of omnipotence has certainly taken a hit.  But I don’t think the internal takeaway is going to be that Xi blew it and Li Keqiang is unfairly taking the fall.  I think it will be that liberal reformers were na├»ve in thinking that the laissez faire “let a hundred hedge funds bloom” attitude could deliver a stable, manageable financial sector.

12.   Should be remembered that “liberal reformers” have the ear of the Western press while Xi Jinping probably doesn’t give the highest priority to what’s written about his economic policies overseas.  So it’s important to bear in mind the distinction between insider tittle-tattle and insider ass-covering.  In coverage look for the perennial “Li Keqiang is an economist, Xi Jinping is just a chemical engineer” tell in order to get an idea of who’s pushing what.

13.   If “liberal reformers” spend too much effort defending themselves in the Western press, I’m guessing ugly exposes of corruption, lax regulatory oversight, whatnot by China’s would-be masters of the financial universe will start popping up in Chinese media and courts.  And I expect there’s plenty to play with.

14.   The key internal fingerpointing, in other words, may turn out to revolve around “how did the bubble form so quickly and unwind so chaotically?” rather than “dang, we shouldn’t have violated the market with intervention”.

15.   I think the market will show some stability now, not necessarily because it’s reached a rational P:E, but because the insiders have cashed out and the pressure from the carry trade mechanism is gone with the collapse of returns on the China stock markets.  In fact, one way to look at the RMB devaluation that appears plausible to me is that the CCP instituted it in order to break the dollar peg and gut the carry trade.

16.   If you really want to get into the financial warfare weeds, PLA fireeater Maj. General Qiao Liang (who, according to Francesco Sisci has the ear of Xi Jinping) has put forth the theory, well, accusation, that the United States knowingly pumps up emerging markets and then crashes them.  In this scenario, the RMB deval would be a pre-emptive move to wind down the carry trade and deflate the bubble before the Fed yanked out the plug this fall with a rate hike.

17.   The carry trade equation will reverse and we’ll see capital flight out of PRC into and via Hong Kong, something to remember when the free-market wonderfulness of the Hong Kong stock exchange is extolled.

18.   The CCP can decide if it wants to cherish forever the big pile of paper it accumulated in trying to prop up the market.  I think it would be a great idea to make the shares disappear—swap them for some crappy debt that is immediately defaulted on and forgiven—but I suppose the irresistible temptation will be to hang on to the shares with the expectation that prices will recover and they will be bled into the market for triumphant “we didn’t lose a mao!” crowing.

19.   Bottom line, I think, a major embarrassment for Xi Jinping, a source of division and discord within the elites, and a big knock to the financial machinery that will set back reform plans for a couple years.  It will also strengthen the hand of the go-slow factions that, for various interested and disinterested reasons, don’t want to see the SOE/business as usual/corruption toleration applecart upset.  I expect Xi is currently weighing the options of either hammering these guys pre-emptively before another mis-step weakens him further, or cutting his losses and risks by concluding a truce with his opponents.

20.   Regardless of what happens to Xi Jinping’s mojo, I think the CCP learned an expensive lesson about financial bubbles.  And I think the lessons concerning regulation, monitoring, and control are somewhat different from those free market advocates in the West would like them to draw.