China's Headaches Are the Fed's, Too
It's time to call Beijing's aggressive stock-market intervention what it really is: quantitative easing, Chinese style.
With deflation pressures mounting, China's central bank would seem to have plenty of incentive to follow counterparts in Japan, the U.S. and Europe down to zero rates and beyond. Governor Zhou Xiaochuan has held off because of two overriding fears. First, an unknown number of companies might default on dollar debts if a full-fledged QE program depressed the value of the yuan. Second, that kind of stealth devaluation might scuttle Beijing's hopes of adding the renminbi to the ranks of the world's reserve currencies.
Instead of intervening in debt markets as the Fed, Bank of Japan and ECB have, China has thus targeted stocks directly. The goal -- to commandeer assets as a transmission mechanism to gin up growth and confidence -- is the same. Indeed, in some ways the Chinese strategy is even more direct about its aims.
This is the worrying part, though: Just as those other nations have, China is going to have a very hard time exiting from its easing program. And its difficulties are going to compound the challenges faced in Washington, Brussels and Tokyo.
Monday's 8.5 percent stock plunge in Shanghai followed reports Beijing was considering how to withdraw support for shares. The scare probably postponed any such moves indefinitely. Earlier this month, Zhou sounded much like his global peers when he pledged "ample liquidity" to the market. On Tuesday, he again promised to stay the course, saying the PBOC would "stabilize financial market expectations and continue to support the real economy."
While probably necessary to forestall a panic, there are obvious costs to this approach. Beijing should be accelerating the transfer of productive assets from inefficient state-owned enterprises to higher-potential private-sector industries. The more time authorities spend obsessing over stocks, the less they'll have to shore up China's foundations.
This matters outside China as well. True, the impact of a stock bust on the broader Chinese economy can be exaggerated. Only about 9 percent of households participate directly in the market, and the share of equities in totals assets is in the "low single digits," says Tom Orlik, Bloomberg economist in Beijing. As such, he notes, "early signs suggest China's consumer mood has been unaffected by the collapse in the equity markets."
But the psychological impact globally is unmistakable. For one thing, investors worry about the knock-on effects on Chinese bank balance sheets. Bad-loan growth accelerated in the first quarter, up 64 percent year-on-year at China Merchants Bank alone. Falling share prices are putting intensifying pressure on asset quality. Only time will tell how the recent $4 trillion loss in market value will affect megabanks such as Industrial & Commercial Bank of China, China Construction Bank and Agricultural Bank of China.
For another, the efforts to calm stocks are affecting China's interest-rate trajectory, adding to the risk of a global shock. In 2013, speculation the Federal Reserve would begin tapering roiled emerging markets and demonstrated what can happen when a major central bank tries to exit QE. China could soon provoke its own taper tantrum. A deeply concerned International Monetary Fund, for example, is urging Beijing to unwind its QE-via-stocks scheme. Were Beijing to acquiesce, global markets could follow Chinese shares lower. The resulting volatility and damage to business and consumer confidence around the globe could trap the Fed and ECB in ultralow-rate territory longer than officials realize.
Risks also abound if China goes the other way, BOJ-style. Sensing its legitimacy is on the line, President Xi Jinping's party may throw more and more inducements at the markets. But continuing to feed a financial monster of the government's creation will make it harder to control -- and increase risks of a crash. Along with PBOC stimulus, support efforts are sure to be financed by fresh borrowing by local government and state-owned enterprises already suffocating on debt. As one huge bubble (debt) feeds another (stocks), China's problems could become the world's in a repeat of Japan's asset reckoning.
As Beijing battles hedge funds in the months -- or years? -- ahead, Fed Chair Janet Yellen will also have to keep a close eye on China's dollar holdings. In the second quarter, China's currency hoard fell to $3.69 trillion, the lowest since 2013. Beijing may be tempted to draw down reserves even more to prop up stocks. The slightest whiff China is dumping its $1.2 trillion of dollars would send shockwaves through world markets and U.S. borrowing costs higher.
In recent years, the Fed bent over backward to show it's not a threat to global stability, or to its central banking peers. Now at least some of that burden falls on Beijing.
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