Chinese policy makers seem to have exhausted whatever magical powers they had been using to keep their economy aloft. Chinese stocks have been plunging even as Beijing has used every trick it knows to support the market.
The truth is that the plunge in Chinese stocks was long overdue. China’s longest-ever bull market was government-driven, fueled by central bank liquidity and a public-relations bonanza. The question now is whether Beijing's policy apparatus has lost its ability to impose its will on stock prices. And there's good reason to think it has.
Stocks slid 3.3 percent Monday even after an aggressive three-pronged easing effort over the weekend. People's Bank of China Governor Zhou Xiaochuan cut the benchmark lending rate by 25 basis points to a record low of 4.85 percent, slashed the deposit rate to 2 percent and reduced required reserve ratios for some lenders. As stocks plunged anyway, China's securities regulators tried to cheer traders by announcing they would consider suspending initial public offerings in order to increase demand for existing shares. The sell orders still accelerated. Next, government officials assured the record numbers of individual investors entering the market that the risks from margin trading are controllable. Selling ensued regardless.
Only time will tell if Beijing's bag of tricks is empty. But if it is, the fallout on global markets could dwarf the impact of Greece's flirtation with default. The world, after all, has had a few years to contemplate a Greek exit from the euro. But if the world's biggest trading nation suddenly hit a wall, it would be a catastrophe of a different order, wreaking havoc on economies near and far.
At the very least, it would kill Japan's nascent recovery, push Australia into its first recession in a quarter century, send shockwaves through South Korea, Indonesia and India, and devastate commodity-exporting nations everywhere. Officials in Beijing get this, of course. That's why they're conjuring up every policy they can think of to stabilize stocks. But Beijing is suddenly realizing that it can't pull its usual levers with the same results.
More monetary easing is inevitable with Chinese producer prices now in negative territory for 39 months straight months, says former PBOC official Yu Yongding. "At a time of slowing economic growth and massive corporate debts, a deflationary spiral would be China’s worst nightmare," Yu writes in a new Project Syndicate op-ed. "And the risk is mounting." What's more, says economist Chen Long of Gavekal Dragonomics, "the challenges of slowing growth and a high level of debt will push China ever closer to the zero interest-rate policy that already prevails in other major economies."
But sharply lower borrowing costs might just encourage more irresponsible lending at a time when local government debt already exceeds Germany's $3.7 trillion worth of annual output. Conventional stimulus measures have lost traction amid factory overcapacity and a fast-increasing number of ghost cities. The solution, of course, would be for President Xi Jinping to accelerate structural reforms to wean China off excessive investment and exports. It's only by reining in state-owned enterprises that China can create a vibrant private sector driven by small-to-midsize services companies that generate high-paying jobs.
Instead, Xi's team has spent the last 10 months ginning up stocks with government sorcery. The plan was straightforward enough: Companies would harness rising shares to pull off IPOs to pay down debt, while households would feel richer and spend more. If stocks got wobbly, the government could just step in and keep the party going. That lasted until June 12, when Shanghai shares topped out. Since Friday's 7.4 percent plunge, Beijing has used all its usual policy tools with no success.
It's possible the turmoil in Greece has played a role in China's latest downturn. Emerging-market stocks, after all, fell 2 percent Monday, the most since Dec. 1. But China's sell off is also a sign that the magic wand Beijing has lorded over its economy in recent years is losing its power. And when investors wake up from the government's spell, they're unlikely to be very happy.
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