Regulators must get to grips with China’s stock-market manipulators, but are they up to the job?

Two cheers for the recently departed China Securities Regulatory Commission chairman, Xiao Gang (肖鋼), who left after not succeeding at the impossible task of propping up China’s overvalued stock markets. He has been replaced by Liu Shiyu (劉士余), who, like Xiao when he started, has no regulatory experience. Not that it would help.

READ MORE: CSRC chief Liu Shiyu faces uphill battle to reform China’s stock markets

In January, Xiao summed up China’s stock market problems: an “immature bourse and participants, incomplete trading rules, an inadequate market system and an inappropriate regulatory system”. That pretty much covered things, except the real causes of the market rout: overvalued stocks, an overleveraged, slowing economy with excess capacity and little hope for consumer spending to take up the slack. January’s massive issuance of new bank debt would seem to indicate that Beijing is less optimistic than it’s saying about consumption replacing investment in our lifetime.

Meanwhile, as central bank governor Zhou Xiaochuan (周小川), missing in action for months, reappears and stretches linguistically to distinguish between “capital outflows” and “capital flight”, trillions of dollars have left the mainland. Whatever you want to call it, the capital is gone and, because it’s going to repay dollar debts or buy Western companies by the billions, or to buy offshore insurance policies or Vancouver condominiums by the millions, it’s not coming back.

Xiao’s last straw was the spectacular failure of his signature solution to stop the market meltdowns that began last summer: circuit breakers. Circuit breakers have been around since 1988, when the Brady Commission recommended them as a means to temporarily halt relentless selling by institutions so buyers had time to gather and come back into the markets. I spent that spring in a class taught by a senior staff member of the commission, which identified the causes of the October 1987 “Black Monday” crash and fixed them.

The start of the decline “ignited mechanical, price-insensitive selling by a number of institutions employing portfolio insurance strategies and a small number of mutual fund groups reacting to redemptions. The selling by these investors, and the prospect of further selling by them, encouraged a number of aggressive trading-oriented institutions to sell in anticipation of further market declines... This selling, in turn, stimulated further reactive selling by portfolio insurers and mutual funds,” it found.

READ MORE: China’s market regulator cannot be a player, too

Picture wide-eyed retail investors in China, heavily leveraged gamblers lured into the markets by government propaganda – “good times are just beginning”, the People’s Daily blared last May – staring at the mayhem on their screens as the 5 per cent circuit breaker approaches. They’re not gathering to buy, they’re gathering to sell, frantically tapping in orders so they can get it done before the next circuit breaker, at 7 per cent, kicks in.

Which is exactly what happened on January 7, the second and final day of the circuit breaker’s short life. The ticker was in relentless free fall, wiping out billions in market valuation in just 14 minutes of trading.