Tuesday, August 4, 2015

Stability and Gunpowder.

Up until recently, the renminbi was considered more attractive than other currencies, especially the U.S. dollar. The assets that could be bought with renminbi also held allure. This sentiment seems to be changing. An example of this is an article that appeared in the August 3, 2015 edition of the Economics Observer.
过去数周,内地股市的波动令不少投资者惊心动魄。香港市场同样出现波动,可是同样出现波动,可是上市企业的基本面其实并无出现大变。当政府宣布一连串稳定A股市场的措施,包括延迟A股的IPO、上市公司的主要股东不得在一段时间内减持,推动内地大型券商投资蓝筹股,鼓励上市公司、管理层及员工回购公司股份,市场相对稳定下来。 [Over the last few weeks, the volatility in the Mainland stock market has frightened quite a few investors. The Hong Kong market has experienced similar movements, but the basic composition of listed companies has not changed. When the Chinese government announced a series of measures to stabilize the A-share stock market, such as delaying IPOs for A-shares, prohibiting the major shareholders of listed companies from reducing their holdings for a period of time, pushing large brokerages to invest in blue chip companies, and encouraging listed companies, management, and staff to buy back their own company shares, relative stability returned to the market.]
All economic assumptions and theories on human action rely on the principle of ceteris paribus. For some action or event to have a direct and expected impact on some other variable, all other factors must remain equal. This rule seems to always change when government intervention is being evaluated. In the case of the Chinese stock market, the market began to fall in mid-June. The authorities introduced the measured above to stop the decline. Once stock prices stopped plummeting, and on some days even rose, the authorities celebrated their achievement in bringing stability to the market. However, we should not evaluate the effects of a policy as the policy is being implemented. If the measures and guarantees were removed, prices would plummet further. Therefore, we cannot evaluate market stability until the level of government intervention returns to its previous level.

A counterpart to stability is certainty. Government intervention in the market is adding uncertainty, which means the same measures that were meant to maintain stability are precisely the reason more instability will exist in the future.
目前,内地仍然拥有不少刺激经济及股市的弹药,特别对于国际投资者来讲,他们更希望见到内地实体经济及金融市场的基本框架能持续完善,改革道路持续,长线而言将会利好当地股票发展。短期而言,对有兴趣投资中国概念的国际投资者,由于估值较低,企业管治环境较为成熟,港股的确显得更具魅力。 [Currently, the Mainland still has a sizeable amount of gunpowder left to stimulate the economy and the stock market. International investors would rather see continued improvement in the basic foundation of the real economy and financial markets, as well as continued progress on the road to reform. This will benefit the development of Mainland equities over the long term. In the short term, international investors interested in investing in China are more attracted to Hong Kong equities because of their lower valuations and more mature corporate governance.]
After the policies of the People’s Bank of China caused an explosion of misallocated capital, corporate debt, and equity overvaluations, we primarily should be concerned that it still has any gunpowder left.

There are two factors that will aggravate the People’s Bank of China current policies. First, further monetary inflation will decrease the value of the renminbi on foreign exchange markets. It is unlikely that the next domestic credit bubble could attract as much foreign capital as the Great Ease Forward did in 2008, which means any marginal increase in short-term economic activity would be erased by currency devaluation.

Second, the artificial credit created by the People’s Bank of China and the factional reserve state-owned banking system will further delay the necessary adjustments in the real economy. The underlying assets and the cash flows derived from them will be less attractive in the global economy. In the example given above by the author, Hong Kong equities are more attractive than Mainland equities. Not only does a more international renminbi need to compete with foreign currencies, it must compete with the underlying assets that can be purchased with those currencies. In this case, capital employed as Mainland equities denominated in renminbi will be liquidated and then converted into Hong Kong dollars to be re-employed as Hong Kong equities. Thus, as the Chinese stock market goes, so goes the renminbi.