The Shanghai Market Calls the Tune

The Shanghai and Shenzhen stock markets are still hogging the spotlight. Although down 18.0% from its recent peak exactly one month ago, the past three days have been good for Chinese stock market investors. After rising 0.60% on Tuesday and 1.17% on Wednesday, the SSE composite was up a very smart 4.79% today.

So what happened? Better-than-expected earnings from Chinese corporations? A surge in US household income and a decline in US unemployment boosting the prospects for China’s tradable goods sector? A huge new loan number for the month of August?

Actually, none of the above. In fact the US numbers look especially bleak for China. In spite of some seemingly good news on the macroeconomic side, unemployment in the US is still rising, and even that masks the depth of the problem. Many Americans who have lost jobs have since then found new jobs, but at lower pay, so that although they don’t show up adversely in the unemployment data, they nonetheless represent lower income to workers as certainly as rising unemployment does, and this will have an impact on future private consumption.

Societe Generale’s ever bearish Albert Edwards had an excellent piece on the subject on August 6, in which he argues that:

US nominal household incomes are now contracting at an unprecedented rate. The largest component of household income is wages and salaries which had been declining some 1% yoy. But after revisions the statisticians now admit to an unprecedented 4.8% decline! Total pre-tax household income is now recorded as falling 3.4% yoy in June.

If US household income is declining so sharply, we can’t really expect a sharp pick-up in imports, even ignoring the fact that households are also in the process of deleveraging, and so cutting back even more sharply on consumption that their incomes might indicate. But in spite of still-bad news in both the external or internal environments, the markets are nonetheless in a much better mood than they were just a few days ago. Why? The People’s Daily explains:

Chinese equities climbed Wednesday after the country’s securities regulator said it would take measures to promote the steady and healthy development of the market.

Or, if you prefer Bloomberg’s slightly more forthright explanation:

China’s stocks rose the most in two weeks on speculation regulators will adopt measures to boost the nation’s equities following declines in the past month.

The main cause of the surge seems to be a statement made by Liu Xinhua, vice chairman of the China Securities Regulatory Commission, at a forum in Beijing Wednesday which was proclaimed on the front pages today of China’s two biggest financial newspapers, the China Securities Journal and the Shanghai Securities News. Mr. Liu promised that regulators will promote a “stable and healthy” market. This has been interpreted to mean that the authorities will not let the market continue falling, and will introduce measures to force it up.

Bloomberg continues, with something that is widely acknowledged but wasn’t covered in the People’s Daily article:

The government may take measures to stabilize the market before the 60th anniversary of the founding of the People’s Republic of China on Oct. 1, the start of a weeklong holiday. “They want everything to be stable and in harmony,” said Francis Lun, general manager of Fulbright Securities Ltd., in an interview with Bloomberg Television today. “They will approve more stock market funds and allow them to buy into the market.”

There is a general sense that no one wants the markets to misbehave before the all-important October 1 celebration of the sixtieth anniversary of the birth of the People’s Republic. Needless to say this begs the question about when exactly should you, as an investor, get out of the market? The day before? But if everyone knows that, then shouldn’t you get out two days before, or maybe three, since everyone has presumably figured that one out too?

In 2006, 2007 and 2008 I wrote often about the dangers of this sort of market signaling. There may be perfectly good reasons to want to manipulate the markets with non-fundamental information, but every time this happens it further undermines the development of a healthy capital market that allocates capital based on economic prospects by undermining the value of fundamental information and reinforcing the value of speculation on government intentions. Still, on such an important anniversary I suppose it was totally unrealistic to think that the authorities would let angry investors spoil the party.

The stock markets may have also taken some heart from a good, although sobering, speech from Premier Wen when he met with World Bank President Robert Zoellick earlier this week. According to an article in Xinhua, Premier Wen said that

China’s government would continue to pursue proactive fiscal and moderately easy monetary policies. ”We will not change the orientation of our policy,” Wen said.

Wen said China would fully implement and continue to enhance and perfect policy in response to the international financial crisis to achieve the goals of economic and social development.

This was taken by everyone as a pretty clear conformation of what I discussed in last week’s entry – that although there were increasing worries about the cost of the fiscal stimulus package and the lack of an “exit strategy,” in the end the State Council and the policy leadership were still more worried about a sharp slowdown in growth than about the risks of excessive investment:

I wonder, and I know I am not the only one wondering, what Zhongnanhai is thinking as it sees the impact of these rumors of a contraction in the furious rate of credit expansion. For one thing it seems that there are only two positions on the switch – “surge” and “swoon” – and I suspect that very quickly we will see the switch turned back to “surge”. Although there seems to have been a little upward blip in US import numbers, I think this represents more of a temporary bounce from a steep earlier decline, and that the external environment continues to be very poor.

My guess is that if the local stock markets do not soon recover their bounce (and they won’t without government help) and, even worse, if we start to see the awful sentiment seep into the real estate sector, Beijing will once again push forcefully for credit and fiscal expansion. In my opinion there is simply no way that domestic consumption – unless it is primed with government giveaways – can make up the slack quickly enough.

A recent report by CLSA also says that the PBOC apparently believes that one of the causes of the lost decades of Japanese growth was premature tightening in the late 1990s which “killed the momentum of economic recovery when it was only in the budding state,” and so the PBoC has cautioned against doing the same in China. It is better to be too loose than too tight.

Although I think perhaps the right comparison is not with Japan in the later 1990s but rather with Japan in the late 1980s, this “lesson” was reinforced by another, according to the same report:

Beijing seems to agree with Ben Bernanke that “The correct interpretation of the 1920s, then, is not the popular one–that the stock market got overvalued, crashed, and caused a Great Depression. The true story is that monetary policy tried overzealously to stop the rise in stock prices. But the main effect of the tight monetary policy, as Benjamin Strong had predicted, was to slow the economy – both domestically and, through the workings of the gold standard, abroad. The slowing economy, together with rising interest rates, was in turn a major factor in precipitating the stock market crash.”

Although I think I agree with Bernanke, again, I am not sure this is the right lesson for China. The problem is that loose monetary policy is exacerbating the imbalance that China needs to work though, since most of the expansion is being directed at investment in expanding current and future capacity, but this comes at the cost – which was not the case in the US – of constraining the future growth in domestic consumption. Without rapid future consumption growth, as I have argued many times, I just don’t see how China can support rapid GDP growth once the huge fiscal push becomes unsustainable and runs out of steam.

Clearly this concern is still part of the internal debate. Chi Fulin, president of the China (Hainan) Reform and Development Research Institute and a member of the Chinese People’s Political Consultative Conference had an interview which was reported in an article in today’s People’s Daily. In his comments he makes many of the same points I have been worrying about, albeit perhaps in a more politically acceptable way:

Chinese leaders should rethink the country’s reform package amid changing global and domestic situations and take “quicker and radical” steps to move toward a market-oriented economy by 2020, said a senior political advisor. The reform measures should speed up urbanization, break down industry monopolies by the State, deregulate energy, offer equal social welfare for both rural residents and urbanities, and improve the government’s efficiency.

“Our top leaders should take quicker and radical measures in these endeavors within the coming two or three years. By doing so, China can do a better job in post-crisis management as well,” Chi Fulin, president of the China (Hainan) Reform and Development Research Institute told China Daily in an exclusive interview. “Looking at the goal of realizing a market economy by 2020, we cannot afford to lose the time window of the next two or three years in the reform.”

Several times in the interview Chi mentions the “urgency” of the need for reform, which included removing many of the production subsidies, price deregulation of resource products, and reducing the State’s industry monopoly. My interpretation of his comments is that he is, as politely as possible, warning that the government still hasn’t taken the necessary steps to restructure the economy. He concludes “Whether consumption can become a leading engine of China’s economy depends on how successful the reform is.”

——-

On a very, very different subject, I hear that there were more demonstrations and unrest in Urumqi Thursday. My understanding is that the large group involved met in a square over claims that people in Urumqi have been attacking innocent people with syringes. There have already been demands for retribution. Here is what China Daily says:

URUMQI: Police have seized 15 people for stabbing members of the public with hypodermic syringe needles in northwest China’s Xinjiang Uygur Autonomous Region, a senior local official said Wednesday. Of the 15, four were officially arrested and prosecuted, said Zhu Hailun, head of the political and legal affairs commission of the Communist Party of China (CPC) committee in Xinjiang.

This is way outside my area of expertise, but ever since the early days of AIDS there have been persistent reports around the world of AIDS victims randomly attacking people with syringes and injecting them with infected blood. I have no idea of what has happened in Urumqi, but I wonder if this talk about syringe-wielders isn’t underpinned by these kinds of rumors. I am not a weapons expert, but it seems to me that attacking someone with a syringe would otherwise be pretty inefficient. Even an ordinary beer bottle has to be a better weapon than a syringe.

For what it’s worth, it seems that as widespread as these AIDS-infected-syringe claims have been in the past, and as certain as many people are that they have occurred, there has apparently never been any credible confirmation of such an attack — no eyewitnesses, no police records, no medical records. This is apparently one of those urban myths that we seize upon for reasons that may have more to do with our own fears than with any reality. I’d be curious to see whether or not these attacks in Urumqi are confirmed and, if so, to get a better sense of why anyone would use such a weird weapon.

Comments

[Billy Gee:]

Mr. Pettis, thank you for your interesting articles.

Are all companies on the Shanghai Index under either national or local government control with minority investment available to other investors?

Sep 03 10:32 AM

[CautiousInv...:]

I read your blog earlier today and delight in the content.

In addition to stabilizing the market in advance of the 60th anniversary, I believe they are trying to create a wealth effect to stimulate current consumer spending, not wanting to wait for the needed structural changes.

Another interesting twist is that most of the stimulus is being channeled through large SOE, who are notoriously inefficient but who have a greater impact upon reported GDP. I'm not sure why this is but it has been reported on more than one occasion.

Looking forward, it would occur to me that more spending should be devoted to (1) social and medical infrastrucuture and (2) private investment. The former will, perhaps, reduce the savings rate while the latter will better allocate scarce resources.

Sep 03 10:55 AM

[odin:]

The story about the attacks is significant not so much for its contents (after all, I'm sure more people get hurt by more violent levels of crime in areas bigger than Urumqi) but as a reflection on the state of the people. The fact that fear (especially rumors) gets wings like this among a large section of population (enough to get international attention) and rapidly gets transformed into anger against the GOVT (www.timesonline.co.uk/...) is significant and worrisome.

From a psychological perspective, it reinforces the idea that despite other signs that may be impacted by governmental interference, the ordinary people are concerned about their future, nervous about the changes that may come and distrustful of the government to solve their problems. It is in such environments that random rumors grow bigger than life and cause headaches for governments and force them to make sub-optimal choices.

Of course, this is just one incident and I wouldnt want to let the imagination run wild solely on this story but I keep my ears open for similar signs of discontent and fear (which to me portend tougher economic times)

Sep 03 03:30 PM

[mcl_mixer:]

They were also going to prop up the stock market until after the Olympics, but it tanked a few months early. Could happen again.

Sep 03 04:47 PM

[Michael Clark:]

Again, a very interesting article. Your final comment on the syringe attacks is VERY bizarre. I agree with Odin: if true, this injects (sorry!) a whole other level of insanity to the social picture of China. I realize there is significant ANGER between the haves and have-nots in Chinese society. But I never thought the haves, in this instance (those having the AIDS virus) would be attacking the have-nots. Very strange note, indeed.

Sep 04 12:33 PM

[James Lewis:]

Michael, have you been picking up on Chinese SOE's plan to cancel derivatives contracts with the Western Banks because they are so underwater. This is what sent shockwaves through the market recently both from the angle of the state of the SOE's, but also putting the whole financial market framework under risk. It poses the question if the SOE's can refuse to honour derivative contracts (backed up by the central government), then is there any stability in the market framework.

Liu Xinhua comment about stability etc i feel was also aimed at re-assuring everyone around these issue of cancelling the contracts.
It is very obvious that the losses taken on these contracts are truly huge. In fact I dare to say so huge that many of the SOE were insolvent when the commodity markets were trading lower at the start of this year. I dare say this had something to do with the SOE's taking on huge speculative inventory in order to push the spot price up (which had the dual effect of making spot price more in line with futures price - ie reducing the spread and also making their massively leveraged derivative positons less damaging)

This incident also brings to light that budget sheets on the Chinese companies/banks were (maybe are) probably no better that their western counterparts. Which is quite a scary thought...

The governments response shows once again that in effect the Chinese government is now implicitly/explicitly guarantor for everything stupid the Banks/SOE's do as well as the markets. The market is in effect a symbolic mirror, of 'Daddy is rich, he'll get me out of trouble if I do anything naughty'. And this can only lead to a corporate culture of gambling and corruption, I wish I was a high level trader for one of the protected instiutions. This can only lead to bad investments and huge write offs. It is no different to making State Banks lend to unprofitable SOE's for political/employment reasons and this destroyed the banking sector in China at least twice. Chinese Rogue

When I think about things I recall I use to believe the government very much wanted the stockmarket to go up to create a wealth effect to stimulate domestic demand and that was part of their tool box. Now I believe that in fact the government wants the stockmarket to entice the chinese savers to move their money out of savings in order to allocate capital to their 'strategic corporations'. The best way to do this is close off flows going out of the country, then creating asset bubbles to entice savers money into the market which is then used to buy overvalued stock of their 'strategic corporations' during the distribution phase. Anyone that has seen the huge amount of stock coming into the market shortly because of lock-up expiration will be able to connect exactly why the market is being talked up by the government.

This is all being done on the premise that asset price bubbles in China are fine because if they keep all flows from leaving China then all that is happening is money is being lost by some and distributed to others. We all know who the winners are and the losers are. Of course this is not true, because there is always an element of karma in economics.

When this gigantic distribution is finished, confidence among the people can only go lower. Once again a lot of money will be lost by the masses. So in the medium term without large increase in wages, consumption can not go higher.

I hope everyday that China can truly reform to the better of its people and the evolution of the prosperity of the world. But it seems the current aging generation is motivated by power, wealth and keeping their cronies rich at the expense of the masses. This is not congruent with increasing domestic demand and I am slowly but surely losing hope that things can change in the short term.

Sep 04 12:41 PM

[Alphameister:]

So much sound and fury and conspiracy theory! I suppose it is heretical to imagine that China may be doing whatever it can to promote strong economic growth in the short run and the long run, realizing that strong economic growth is the best way to produce a strong stock market. If they had any illusions that their central committee can control markets, the swoon by their stock markets in advance of the last olympics should have disabused them of that notion.

Sep 04 06:27 PM

[rick12345:]

The cold war ended 20 years ago, while Liberal Imperialism died in the last century. Lick your wounds and move on.
Subsequently, I wonder how they acheived 8% growth if they're getting it so wrong.

Sep 04 09:57 PM

[HaavBline:]

A modest a week bounce after a 25% correction in a month, after a 100% rally in 9 months, does not require goverment manipulation.

All it takes is for Chinese goverment to take another incremental step in opening the stock markets to eager foreign investors. Rumors has it the upper limit for each approved foreign investment companies in the QFII scheme will be expanded to $1B, a 25% increase.

Sep 04 11:53 PM

[doubleshortetf:]

CCP (Chinese Communist Party) is looking for sucker foreigners to pile in and sustain the bubble. Thus they've just increased investment quota's for foreign funds by 25%. Talk about impeccable timing...

From Bloomberg:

“We have raised the limit for each fund to $1 billion within the current total $30 billion size of all funds to encourage more good investors to come in,”

Got to give credit to CCP coots to invite the "foreign devils" suckers into the greatest gambling den where the house is CCP. And there will be plenty to see all these fools who think China will save the world from economic calamity. Don't they know China's GDP per capita is 3rd world?

Sep 05 12:19 PM

[doubleshortetf:]

China is considering bailing out of bad derivatives bet?

China is notorious for corruption and the CCP (Chinese Communist Party) ignoring and bending the rules to weasel out of bad financial bet made by SOE (state owned enterprises).

From Reuters couple of days ago:

Beijing's derivative default stance rattles banks

"It's like the father suddenly told the creditors of his debt-ridden son that his son won't pay any of his debt," said a lawyer from the derivatives risks committee of the Beijing Lawyers Association."

* State-owned firms may default on commodity hedges - report
* Bankers dismayed, confused by report; seek more details
* Lawyers question legality of the move
* Traders suspect lurking losses may have prompted warning

Just walk away from bad bet SOEs made hedging. Talk about bunch of unruly cowards...

This is the very government you China fans "invest" in where the corrupt CCP changes rules in blatant mockery of international law and not honoring contracts.

Sep 05 12:34 PM

[Michael Xia...:]

Your analysis for the China market was great. I only cannot agree with your comments about what is happening in Urumqi.

Like you, I don't know what happened there because I was not there. Unlike you, my first feeling was the same as in the day 9.11.2001. What I care about are those innocent people who were attacked rather than suspect the kind of weapons criminals used. I won't suspect why the muslins used airplanes than nuclear bombs as airplane cause way less damage. Unfortunately this is your logic I can read.

Even after hundreds of people died in the crisis last month, people who were mourning their own brothers and sisters in 911 now prefer to focus on criticizing than victims. Are values of different lives same in someone's mind? I doubt.

Sep 05 06:10 PM

[vamm:]

a knife or a bottle don't give you much edge unless you have some skill. i would possibly (small chance, i'm not much of a fighter) take a guy on if he was holding his blade wrong, but i wouldn't touch a 4 year old who had a syringe... one little scratch, and who knows how the rest of my life will play.... so basically i think the assailant knows there are a few ways to argue with a knife but you can't win an argument with a syringe (unless the other guy can king-hit or jackie chan it, and very few people can do that).

the info in the media sounds pretty dodgy to me. from what i've read there have been 400+ attacks but no reported infections. it could be that the gang behind it is firing blanks, that would be ironic (and to my mind quite funny (it's like, oh no! i've been infected with ... nutrients? gee thanks)). or it could be an attempt to placate people with a message of 'no real harm done.' but 400 and no infections seems odd.
also, a number of ethnicities have been targeted, but then some official put it out in the media (sorry too lazy to cite) that the attacks have been done by separatists. maybe the victims just looked han, i don't really know, but, it sounds like more lame 'blame everything on the separatists.' i guess when all you've got is a hammer, every problem starts to look like a nail.

my guess is, it's a bunch of kids gunning for lunch money.

Sep 06 02:37 AM

[kalasend:]

If you would doubt governments' ability to cook numbers while underlying conditions are bad, you need to study more history.


On Sep 04 09:57 PM rick12345 wrote:

> The cold war ended 20 years ago, while Liberal Imperialism died in
> the last century. Lick your wounds and move on.
> Subsequently, I wonder how they acheived 8% growth if they're getting
> it so wrong.

Sep 06 12:25 PM

[XPP:]

look for the Main China Indexes to hit their 200 DMA before you consider buying. Remember what happened after the China Olympics. It boils down to this: China will have to increase domestic spending via the consumer to make this market go up unless the Gov't is going to dictate the market action on a daily basis forever. The fact is: Because the US consumer has rolled over, imports from China will decline even more as the US goes into the abyss with Obama's marxist administration, nationalized healthcare and MASSIVE unemployment.

Sep 06 01:15 PM

[chennian:]

I generally agree with you on that when government takes on the liability, it nurtures future bad behaviors. But it might be very much different for China's SOE. Because the government can explicitly order a stop on SOE's derivatives trading. It actually did. If you were the trader for those SOE, you would be out of job.


On Sep 04 12:41 PM James Lewis wrote:

> Michael, have you been picking up on Chinese SOE's plan to cancel
> derivatives contracts with the Western Banks because they are so
> underwater. This is what sent shockwaves through the market recently
> both from the angle of the state of the SOE's, but also putting the
> whole financial market framework under risk. It poses the question
> if the SOE's can refuse to honour derivative contracts (backed up
> by the central government), then is there any stability in the market
> framework.
>
> Liu Xinhua comment about stability etc i feel was also aimed at re-assuring
> everyone around these issue of cancelling the contracts.
> It is very obvious that the losses taken on these contracts are truly
> huge. In fact I dare to say so huge that many of the SOE were insolvent
> when the commodity markets were trading lower at the start of this
> year. I dare say this had something to do with the SOE's taking on
> huge speculative inventory in order to push the spot price up (which
> had the dual effect of making spot price more in line with futures
> price - ie reducing the spread and also making their massively leveraged
> derivative positons less damaging)
>
> This incident also brings to light that budget sheets on the Chinese
> companies/banks were (maybe are) probably no better that their western
> counterparts. Which is quite a scary thought...
>
> The governments response shows once again that in effect the Chinese
> government is now implicitly/explicitly guarantor for everything
> stupid the Banks/SOE's do as well as the markets. The market is in
> effect a symbolic mirror, of 'Daddy is rich, he'll get me out of
> trouble if I do anything naughty'. And this can only lead to a corporate
> culture of gambling and corruption, I wish I was a high level trader
> for one of the protected instiutions. This can only lead to bad investments
> and huge write offs. It is no different to making State Banks lend
> to unprofitable SOE's for political/employment reasons and this destroyed
> the banking sector in China at least twice. Chinese Rogue
>
> When I think about things I recall I use to believe the government
> very much wanted the stockmarket to go up to create a wealth effect
> to stimulate domestic demand and that was part of their tool box.
> Now I believe that in fact the government wants the stockmarket to
> entice the chinese savers to move their money out of savings in order
> to allocate capital to their 'strategic corporations'. The best way
> to do this is close off flows going out of the country, then creating
> asset bubbles to entice savers money into the market which is then
> used to buy overvalued stock of their 'strategic corporations' during
> the distribution phase. Anyone that has seen the huge amount of stock
> coming into the market shortly because of lock-up expiration will
> be able to connect exactly why the market is being talked up by the
> government.
>
> This is all being done on the premise that asset price bubbles in
> China are fine because if they keep all flows from leaving China
> then all that is happening is money is being lost by some and distributed
> to others. We all know who the winners are and the losers are. Of
> course this is not true, because there is always an element of karma
> in economics.
>
> When this gigantic distribution is finished, confidence among the
> people can only go lower. Once again a lot of money will be lost
> by the masses. So in the medium term without large increase in wages,
> consumption can not go higher.
>
> I hope everyday that China can truly reform to the better of its
> people and the evolution of the prosperity of the world. But it seems
> the current aging generation is motivated by power, wealth and keeping
> their cronies rich at the expense of the masses. This is not congruent
> with increasing domestic demand and I am slowly but surely losing
> hope that things can change in the short term.
>

Sep 07 12:55 AM

[Michael Pettis:]

JamesLewis, the derivatives story is indeed a very interesting one and continues to cause a lot of concern. Strangely, in all the talk about internationalizing the RMB no one seems to have discussed the impact this might have on the process.

Michael Xia, thanks for your kind comments, but as for the latter, it is nearly two weeks later and there still is no evidence of any concerted attacks nor evidence of actual syringes. The two clear “syringe” cases involve two junkies holding up a cab, something that probably occurs in every big city on a daily basis, and a junkie getting caught by police while trying to inject himself and then “threatening” the police with the syringe. Of the 106 reported cases (actually more than 500 reported but most of them rejected as groundless), no one has demonstrated that they attacks were caused by syringes rather than pins, knitting needles or (yes, several Urumqi doctors said this) insect bites. There has also been not a single case of a recipient testing positive for poison, AIDS, or anything else. Of course I am sympathetic to any real attacks, but I am also concerned about mass hysteria leading to beatings and deaths, which have already happened, according to police reports. The 19-year-old boy, Yilipan Yilihamuwho, pricked the girl with a pin may be an idiot, and may deserve some punishment, but the hysteria has landed him 15 years in jail – a pretty tough punishment

Sep 12 05:11 AM

[djackson:]

They calculate growth very differently than advanced countries. Very easy to manipulate. Quick, easy read at AEI website tells the story: www.aei.org/outlook/10...


On Sep 04 09:57 PM rick12345 wrote:

> The cold war ended 20 years ago, while Liberal Imperialism died in
> the last century. Lick your wounds and move on.
> Subsequently, I wonder how they acheived 8% growth if they're getting
> it so wrong.

Sep 14 10:02 AM