Thursday, July 30, 2015

Fantasy Logic in China’s Stock Market Intervention

The central government has gone so far to prop up the flailing stock market in China that it effectively isn’t a stock market anymore. The restrictions on selling are such that holders of most shares of listed stocks are prohibited from selling, and not just briefly, but indefinitely (officially, for the next year, but the restrictions could be extended at the stroke of a pen). After a few vague threats this week, there is speculation now that prosecutors will start arresting executives of companies whose stocks have declined. Obviously, this won’t stop the decline in stocks, but it will make it more difficult for the stock market to continue into the future.

Government blundering in the stock market intervention underscores the thought that China’s problems are not merely a stock market problem, but are grounded in a fantasy view of economics at the highest levels of government. China’s special advantage has long been that it can intervene quickly and decisively to overrule the conclusions of the free market when the market is in error. In the stock market, though, government leaders seem to feel they can overrule correct economic decisions of the market without paying a price. In effect, China wants to buy all the overvalued shares without paying anything out of its own treasury. The overvaluation in total is an estimated 3 years of national GDP, a sum no government could possibly pay, so it is sensible that this approach is not being considered. One way or another, then, stock values have to decline. The notion of supporting them at current levels is unrealistic, and policy should be pointed toward a soft landing rather than a sustained bubble.

All this could be smoothed over eventually if the economy just kept growing, but there are hints of a recession in China this year: surprisingly soft import and export numbers, the largest housing vacancy rate in history, the ballooning of shadow banking balance sheets. The response to the stock market crash has cost the central government some credibility. If policymakers apply the same kind of fantasy logic to problems in more fundamental sectors of the economy, whether real estate development, manufacturing, or shadow banking, the results could be chaos.

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