On August 14, the People’s Bank of China (PBOC) sold US$3.9 billion in one-year bills. It was the central bank’s standard cash-for-bonds swap with the country’s commercial lenders; the yield was the same as it had been for the previous three weeks and the sale went as planned. On August 21, the PBOC was busy again, this time increasing benchmark interest rates. It was the fourth interest rate hike this year.
What makes these very ordinary events in China’s economic world appear extraordinary is the context in which they took place. While the rest of the world was pumping cash into economies suddenly turned frail by the crisis in America’s low-end mortgage market, and cutting interest rates to reassure frightened investors, China was doing the exact opposite. It was draining money from its economy and encouraging people to keep their savings in the bank.
Rarely has the significance of China’s capital controls been so poignantly expressed. The country lives behind a wall which is being deliberately dismantled, yet at a pace that wouldn’t cause a ripple let alone wave. Behind this wall, the excessive amounts of liquidity are driving up inflation, housing prices and the domestic stock market. This is why the Shanghai Composite Index has gained close to 1,000 points since the back end of July when global markets slipping in the opposite direction. Such is the insular nature of the Chinese market that, for now, it is unlikely to crumble under the weight of a global credit crunch.
But is this insulation healthy in the long-term? No. The country’s stock markets have had to grow up fast but they are really still locked in the playpen.
Surveys have shown that the majority of retail investors don’t really know what they are doing but are happy to drift along on a wing and a prayer – and some third-hand gossip that they treat as insider knowledge. The institutional investors, meanwhile, are playing circus master. New blood is coming in to the market but most of the money is still chasing a small bunch of blue chips. The institutional guys make their money off the fluctuations in an index that appears a little easy to manipulate.
More effective regulation would help, especially if it is of the “hands-off” variety. Investors live in fear that the regulator will wake up one morning, decide there is an A-share bubble that needs bursting and take action. Letting the market find its own way and set its own prices is a much healthier option. Financial futures would also be useful as investors could hedge their risk and profit from a downturn in the market, which might help bring stocks back from their unrealistically high valuations.
In the meantime, the trial program whereby individual investors can participate in the Hong Kong stock market is a positive move. A large chunk of the money (US$500 million in three years, according to JPMorgan) that has been chasing its tail behind the wall of capital controls, sending domestic asset prices ever higher could, in theory, be set free.
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