Circuit Breaker Suspension Renews Concern China Lacks Game Plan

  • Xi struggles to balance state control and free market reforms
  • Market questions China's ability to manage internal tug of war

China Suspends Circuit Breaker Rule

China pulling the plug on a new stock circuit breaker and weakening its currency less than a week into 2016 revived anxiety that the world’s second largest economy is groping in the policy dark.

The moves were yet another misstep in President Xi Jinping’s pledge to loosen the government’s grip on the economy while ensuring stability and preserving faith in the ruling Communist Party. The chaos unleashed reminded investors of last summer, when authorities barely contained a stock-market plunge and carried out a ham-fisted attempt to make the yuan more market-based.

The mixed signals raise the question of whether the Chinese economy is in safe and capable hands, Patrick Chovanec, New York-based chief strategist at Silvercrest Asset Management Group LLC, said in a telephone interview.

“Part of the jitters comes from the fact that you just had an overpriced market and you delayed the correction in that market from last summer until now," Chovanec said. "In the meantime, the economy has deteriorated and people are skeptical of the official numbers and then when they see these kind of policy moves that seem erratic, or don’t seem to make sense, don’t seem to add up, they wonder what’s really going on.”

Invisible Hand Versus Iron Fist

The short-lived end to the relative calm in Chinese equity exchanges has nurtured the impression that Xi is losing the tug of war between the invisible hand of the market and the iron fist of the government. While the suspension of the circuit breaker will allow buyers and sellers to balance the market themselves it also highlighted the more fundamental problem of the government’s inability to telegraph its intent effectively.

"As long as that persists, issues don’t go away in my opinion," Urvish Bidkar, founding partner and money manager at hedge fund Alpha4x Asset Management, wrote in an e-mail. "So the market is left to imply their goals from their actions, and that’s not a great signaling mechanism.”

UBS emerging markets strategist Geoffrey Dennis is a little more sanguine. He believes the turmoil is just part of China’s growing pains, which will eventually ease as the transitioning economy "gets used to a new way of monitoring or driving the currency."

Storm in a Teacup

“It feels to us like a rather nasty storm in a teacup rather than a fundamental reason why markets have to go substantially lower,” Dennis said by phone from Boston. “It’s a miniature rerun of what we saw in August. This is just the implementation of the change in policy that they announced 3-4 weeks ago--they’re going to determine the renminbi against a basket not against the dollar.”

Chinese authorities introduced a trade-weighted currency valuation, calculated based on a methodology similar to the one published by the China Foreign Exchange Trade System, a unit run by the central bank, last month. They said a broader basket is a more reliable gauge of the value of the currency than the dollar-yuan exchange rate. Policy makers have repeatedly said that there are no fundamental reasons for a persistent depreciation in the yuan because the country still runs a large current-account surplus.

Others are happy to take a wait-and-see approach. Tony Hann, who helps oversee about $270 million as the head of equities at Blackfriars Asset Management Ltd. in London, says he needs to know more before deciding whether it was right to kill the circuit breakers.

"It is difficult to say the rule was a failure because we don’t know what would have happened if it had not been in place," Hann said. "To gauge whether the regulation was a failure, one would need to understand what the authorities were trying to achieve by having it in place. I’m not sure we know that."

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