China needs to fix flaws in markets, not hunt for ‘external enemies’
In the history of government interventions in financial markets, Hong Kong’s 1997 gambit is often rated as exemplary. After all, it worked, and nobody felt too bad for the victims, who were “evil hedge fund” types, run out of town by a central banker nicknamed Yambo.
What gets less attention is the follow-up a year later, when the Hong Kong Monetary Authority announced technical improvements to the peg, including the convertibility undertaking, which adds a layer of guarantee to the official exchange rate with the US dollar.
Instead of just punishing investors, at the end of the day the HKMA had to fix a glaring flaw in the very design of the currency regime. Previously, it had been too easy to manipulate Hong Kong interest rates - just sell down the currency to get a spike in rates, and short-sell equities to cash in the subsequent plunge in share prices.
If there are vulnerabilities in a financial system, they need to be fixed. Policymakers can’t expect investors to be nice, or “patriotic,” and ignore the opportunity to make easy profits by bringing an economy to its knees. Just fix the bloody flaw.
This is how China needs to view the current turmoil in its own markets. Rather than trying to persecute “manipulators” – which in this case seems to just be people selling shares – figure out what went wrong, what lessons can be learned and where are the flaws in the system.
Instead, China has literally called in the police. The Ministry of Public Security says it will help securities regulators track down “malicious” short sellers.
For sure, these investors can be merciless. In the wake of the Global Financial Crisis, short-sellers took advantage of the mark-to-market rules on banks’ securities holdings to short sell both the bonds held by financial institutions and the shares. It was a “double play” similar to one Hong Kong experienced in 1997.
Again, though, the solution is not to harass or punish money managers - as satisfying as this might be - but to reconsider the accounting trends on mark-to-market pricing of securities. To fix the mistakes.
What mistakes did Chinese policymakers make? For starters, they encouraged the market bubble. Spreading the gospel of share trading seemed to offer a new growth driver: a boost to confidence, a spur for consumption spending, and a useful increase in the “services” component of GDP.
Then regulators pulled the rug out too abruptly with a crackdown on margin financing in June.
That old trick – let speculators get carried away then smash them periodically – is not an uncommon anti-speculative tactic in China. In recent years, it was employed to temper the interbank market, with occasional deadly spikes in short rates designed to put the fear of god into traders.
It’s like bad parenting. Let the children play unsupervised, then when they get too excitable, and are hanging from the chandeliers, have dad bust in and give them a good thrashing. Many of my forefathers used this parenting technique, and it got none of their kids to Harvard.
Mainland policymakers appear to be focused on hunting for external enemies. They have arrested and/or intimidated reporters, brokers and even netizens for using “sensational” words like “market slump.”
In 1997, Hong Kong authorities also first tried harassment – they increased audits and spot checks at financial institutions, and hinted that operating licences could be snatched away if any “irregularities” were discovered.
It didn’t work and the HKMA had to change tack, with its US$15 billion intervention in markets in 1997. But in Hong Kong’s case, anti-peg speculators had driven Hong Kong assets to record low valuations.
We can’t say the same about Chinese equities, which remain expensive compared to global peers. Yet there are signs of overkill. The heavy capital outflows from China would seem to exaggerate the odds of a major economic or financial crisis.
A number of analysts have speculated that one factor driving the capital exodus is the anti-corruption campaign. Rich people fear they will get caught up in the net, and the government will expropriate their money.
It will be ironic if Beijing ultimately decides the best way to re-establish trust, is to call off the clean-government campaign.
Cathy Holcombe is a Hong Kong based financial writer