Different countries are getting affected by different factors. But they have all come at the same time
Stock markets have been on wild ride this week. Up and down by 1% seemingly every day. Lots of the optimism is fuelled by the assumption of more stimuli from central banks. In contrast the pessimism is fuelled by the collapse of the price of oil. Perhaps the wildest ride is in the Chinese market. Its market increased by 32% in six weeks. Even a fall of 5% in one day did little to dent the rally.
It might be easy to attribute the Chinese rally to the People’s Bank of China (PBOC) recent cut of interest rates. Certainly western markets took this as a sign of further easing and celebrated it like signs of easing in Europe. The paradox is that there probably hasn’t been any easing at all.
Although the broad money supply is up by 13% this year it isn’t getting through to borrowers. It must be understood that the Chinese do not regulate credit by price. In most countries the price of credit is the level of interest rates. In China they regulate credit by the quantity of credit.
One of the largest sources for credit in recent years has been the shadow banking system. The Chinese leadership has determined that the system has become too risky and is placing restrictions on it. This had led to a net tightening of $250 billion since June. Despite the PBOC action, interest rates are rising.
On Tuesday the yield on Chinese ten year government bonds rose to 3.799%, a 0.23% rise this month. It is not only Chinese bonds whose interest is rising. When the PBOC cut interest rates they expected the banks to follow suit, but allowed them some discretion to raise them. They went for it. Three of the largest state owned banks raised interest rates on deposits. This will of course impact loans to businesses and lead to further tightening.
They had little choice. In China’s half reformed system there was too much competition from Alibaba's online bank, Yu’E Bao, and now the stock market.
With real estate declining and money supply expanding, the money had to go somewhere. It went into the stock market with a vengeance. But since this is China, a lot of the buying was fuelled with debt. Margin trading has doubled in six months and totals 881 billion yuan (USD$142 billion), which is equivalent to 18 per cent of the Shanghai and Shenzhen bourses' combined 4.8 trillion yuan market capitalization. This is an astonishing number. The US market capitalization is around USD$ 27 trillion. Its margin debt is at about 2.8%.
The Chinese are borrowing everywhere they can and not just traditional margin accounts offered by brokers. There are anecdotes of bank managers taking out consumer loans and consumers withdrawing money on credit cards all to get in on the action. State owned corporations (SOEs), the recipient of much of the PBOC’s largesse, have jumped on the stock bandwagon with the same enthusiasm that they exhibited, when investing in real estate. There are even daisy chains of SOEs borrowing money on appreciating stocks to lend to hard pressed real estate developers.
The government encouraged investment in shares as an offset to the falling property market. Like central banks in the west, the view that they were being supported has driven speculator’s appetite for risk. But the Chinese government certainly doesn’t like things to get out of hand.
Despite the wild fluctuations of markets, oil may have the last word. It is still falling. The demand most likely from China is simply not there. In addition, the knock on effects of a strong dollar and other weak commodities is having an impact on everything from emerging markets to junk bonds. So we can expect more volatility but most likely the general movement will everywhere will not be in the same direction as the recent Chinese rally.
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William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and speaks four languages.)
