C3S Paper No. 0025/2016
The following is a dialogue conducted on January 23 2016 among C3S members on the subject of the volatility of China’s economy.
B.S. Raghavan IAS (Retd), Former Policy Advisor to UN (FAO), Chief Secretary, State Governments of West Bengal and Tripura, Secretary to the Ministry of Food and Agriculture, Government of India.
K. Subramaniam’s two articles (“Chinese Stock Market Tantrums — To Control or Not To Control?” and “The Circuit Breaker that failed”) are superbly written. They can hold their own before the best analyses of the phenomenon appearing in scholarly journals.
The crux of the issue is contained in the following two observations of his in his second paper:
“Unlike Western markets which are deep and mature and in which major role is played by investment banks and institutional investors who are willing to hold on to shares for longer term, especially when they slide, China’s stock market is populated by millions of individual investors estimated at 6-7 percent of households. For them, stock market is another casino to make huge gains at the earliest. It is not our argument that western stock markets (or even the Indian!) are always stable and players act rationally. They are also subject to herd behaviour.
It appears that the CSRC (China Securities Regulatory Commission) clutched at the wrong tool and at wrong time. It lifted the standard tools available from the shelves of neocon economics and applied them. The breakers failed. It is not surprising that the CSRC has since decided to scrap the breakers.”
However, as he himself would be the first to acknowledge, institutional investors and others, however clued up on intricacies of stock market mechanisms also exhibit irrational exuberance and are prone to panic disorders. Since stampedes of whatever kinds are rooted in imponderables of human behaviour, it is hard to hit upon the right antidotes. That is why circuit-breakers and the like don’t work: In fact, as it happened in China, they make traders more nervous and the markets take a deeper plunge than they normally would have. In any case, the trigger-points are not the result of any precise calculation and are based on the regulators’ judgment and discernment. There are many scholarly papers decrying the excessive emphasis on curbing stock market volatility. I would particularly draw attention to the following essay by Franklin R. Edwards:
The cardinal questions are: Do we or do we not worry about market volatility? Why should regulators’ governments also get into the panic mode, simply because investors are in a panic? What is the trade-off between letting the markets play themselves out and imposing arbitrary curbs whose impact is uncertain? As was envisaged at one time for reining in movements in commodity prices (I participated, as the Leader of the Indian delegation, in one such 53 week long negotiation at UNCTAD, Geneva, for grains), is a Market Stabilisation Fund, made up of contributions from securities companies, insurance firms, banks, institutional investors and listed companies, a better approach?
Some thinking out of the box is necessary, instead of succumbing to orthodox knee-jerk reflexes.
Mr.Sivaraman IAS (Retd.),
Former Revenue Secretary, Ministry of Finance
Government of India.
One respectfully disagrees that circuit breakers are useless. Had the circuit breakers been operational during the Harshad Mehta crisis many million Indians would not have lost money and it was admitted before the JPC. Circuit breakers were introduced in India soon after.
By removing circuit breakers we allow speculators to have a merry run. Those with staying power will benefit and other small holders will sell in panic at low prices to be picked up by the manipulators. If there is a stock market there must be checks and balances in it to prevent marauders from manipulating it. China has a huge number of individual stock holders which does not mean that they do not have any big investors. They are new to stock market controls. They allowed foreign investors only recently. By and by they will learn. There are people who have stated that China was under pressure from funds to remove circuit breakers so that they can pick up the stocks at rock bottom prices which probably is happening as the index has fallen below 3000. The individual stock holders are the people to benefit from circuit breakers not the large stake holders. When stocks plunge without breakers they just go down as bears will come into operation and the very same bears will pick up the stocks at their price level and the unfortunate ones will be the individual stock holders.
The CBS came into existence in 1987 in the US after the black Monday crash. Now it is a standard tool and not uniform. It can be stock specific, general, time specific and so on. China by removing it has let down its individual stock holders. Some people mocked Soros. Nevertheless he is more knowledgeable than most of us and he is respected for his financial acumen.
On January 18 the French president stated that France was having an economic and social emergency. The day before, the media was full of the growing police action against migrants. In fact some countries are hunting them in forests and by-lanes to prevent them from entering. Some forty migrants died yesterday. We do not yet know what will happen when winter recedes. Yesterday the U.S decided to send their 81 airborne division into Iraq to fight ISIS boots on ground. That is a significant decision as 81 airborne is one of the most famous of all units of the U.S army. In India we have the ISIS threat now. Such instability is what the stock market marauders wait for in every country.
In China despite the massive unheard of trade surplus of $605 billion and an enviable growth rate of 6.9 per cent, stock markets plunged. China’s economy is the second largest in the world even on nominal dollars. If that country grows at even 6.9 per cent it is something and with trade surplus of 605 billions the Chinese have every reason to worry why their stock market plunged.
There is a grave crisis facing Europe with the U.K poised to vote on their continuing membership. The Schengen visa system is being questioned. So we are witnessing turmoil in China and also across Europe.
Soros is not wrong and China will know the consequences of their actions to remove the circuit breakers.
T.V. Krishnamurthy
Management Professional, Chennai.
On the subject of circuit breakers, one would like to question whether nations can function without regulations or laws, just because some will misuse them. No markets any where can work without checks, balances and controls. That is the bottom line, no more, no less.
Secondly, it is important to clarify the approach to writers and books on financial markets from great academicians, particularly in the West. They put forth great philosophies, but these are not entirely adopted and followed by regulators worldwide who are burdened with administering economies and markets. We can quote any number of them, but that just won’t justify the ends. They are at best alternate views from fountain heads of intellectualism devoid of practicalities in a real world. They won’t add up to the real tasks and challenges in the practical arena of the world.
Now as far as George Soros is concerned, it is just a matter of opinion. Love him or hate him, one cannot ignore him. As for his views on Europe, on wide ranging subjects, nowhere does he mention in straight lines that Europe will collapse. He merely comments on a variety of matters as responses to questions put to him.
In so far as China is concerned the fact of the matter is that in the absence of very well developed financial markets like in India with Mutual Funds and investment banks playing an orderly and pivotal role for channelizing retail investments in stock markets big time, the Chinese stock markets will continue to suffer with or without regulations. Till such time, financial markets there evolved, and evolved faster.
The shadow banking and the mind boggling size of that was a shame and economic disaster and millions of investors who were led to believe in investing in funds floated by banks with no regulatory oversight have lost confidence in the system. Hence they will always try to encash at the first opportunity.
There are no clues as to how the Chinese are going to grapple with this. But disaster, gloom and doom do not mean ‘no regulations’. Circuit breakers are an inalienable part of regulations.
K.Subramanian
Former Joint Secretary (Retd.) Ministry of Finance, Government of India.
Two more points can be added to my articles mentioned by B.S. Raghavan. One is related to “volatility’ and the other to setting up “stabilization funds.” On both, we have a flood of literature and research done by economists. In the past, more than volatility which is the current fashion, the term used was “contagion.” Stabilization fund idea came from development economists.
The idea of contagion became the ghost that haunted the economists in the IMF and the World Bank. In the late fifties, we had the Mexican collapse when IMF intervened and pump in more than $50 billion ostensibly to save Mexico, but, actually, to save the US banks which were facing default. The IMF’s MD did it on his own without the approval of the Board. Board approval came later (ex post facto) under US pressure. Later, other economies began to fall one after the other. It was then that the idea of ‘contagion’ took route and IMF pundits began to study how contagion spreads. There were hundreds of studies and Working Papers. Most of these blamed the developing countries for their fiscal profligacy and creating unsustainable debts leading to default. They did not notice the roles played by big banks through their lending operations and how such excessive lending led to crisis. The Asian Financial Crisis was the last and worst example. Even as the IMF was praising the Asian Miracle, the economic crisis was simmering under the waters and it did not know it.
Realizing the interconnected nature of global finance, IMF shifted its emphasis to “surveillance” and built elaborate econometric models to assert its capability to study underlying phenomena and forecast crisis. Unfortunately, it could not. It could not even predict the worst ever crisis that took place in 2008. It did not criticize the US for adopting policies (deregulation, etc) which created the sub-prime crisis.
All these aspects come to the newer fad, to wit, volatility. Every banker, every economist and every analyst uses it. But there is no one to spot the scorpion when it takes the stranglehold. Much of the talk about volatility is ex-post facto and not as it evolves. Much of the wisdom comes with hindsight. Even our Reserve Bank had failed. The only exception was Dr. Venugopala Reddy who not only spotted in time, but also took steps to scot it timely.
There are no definitions or parameters to settle issues over volatility. Mr. Alan Greenspan, former Fed Chief, saw “froth” in the market at a time when it had cross excessive bounds. The capitalist class wants to gain from a volatile market when their stocks and asset values soar. Ultimately, it is the gut feeling of an astute and experienced central banker. In performing this role, he must have independence protected by statute.
Coming to stabilization funds, these are tricky affairs. They worked well within a country for certain commodities whose prices were volatile. The idea was promoted by development economists in emerging economies. Some worked very well and many others failed. They failed because of lack of commitment from policy makers in government and the conflict of interest between producers and consumers. Indeed, the real villain who killed these funds was the IMF/Bank under structural adjustment programs. They wanted agriculture to be freed from state control or regulation and to follow the free market. All marketing arrangements under the auspices of the state had to be abolished. Even the Common Fund under the auspices of the UNCTAD died an unnatural death. The argument of the IMF was that commodities are always available in the global market and may be imported whenever needed and at a good price. Malawi disbanded its stabilization fund and when there were drought and floods and its crops failed, it could not import from abroad. It led to a famine and to the death of millions. Since then we have not heard of commodity funds anywhere. Even the FAO seems to have lost its valuable role under the onslaught of commoditization and financialization.
When it comes a stock crisis with global implications, there are different intractable issues There will be global sellers and buyers. Who will determine the loss and who will compensate? Stock market is only a platform and the government concerned whether it is the UK (for FTSE), US (For NYSE), China (for Shanghai etc), India (for BSE/NFT) don’t underwrite the operations. So, who will compensate: the local government or the home government of brokers? How to foresee or estimate the ‘loss’ and work out rules for compensation? How to create the fund and who will contribute and in what proportion? These are issues which cannot be resolved. Finally, the Twin Sisters in Washington will frown upon the whole idea and the US Government and its Treasury Department will scotch the idea in the very first round.
T.V. Krishnamurthy
With reference to the link, “Is George Soros Right that China’s Headed for a Hard Landing?” , it is not anybody’s case that China is not having difficulties in rebalancing efforts in the economy. The first manifestation of this is the stock market crisis. One reads all the reports of the learned experts, but still does not see huge flight of out bound investments from stock markets. Nevertheless FII investment is not significant, being a closed economy. On the other hand FDI is like an elephant and cannot run fast. It is far more complex to fly out.
The market crisis is more on account of domestic selling or anxiety to sell, in anticipation of uncertain circuit breakers. The bottom line is that, there is unlikely to be huge outflows from stock markets in US dollar terms. Hence there is no imminent danger of the currency collapse observed.
Secondly the Yuan is not a globally traded currency which could become a convenient tool in the hands of treacherous currency traders to drive the Yuan down. Read together, these two factors should hedge China against an imminent currency collapse.
With almost $21 trillion on the liability side how the central bank will sustain confidence of the depositors in case inflation flares up even on mere rumors of uncertainties and likely controls on withdrawal of deposits by the depositors from the banks. That in one’s opinion is a possibility despite the huge asset side of the banking system which includes reserves held abroad and within the country. Any way assets held within the country, other than mandated reserves is hugely un-liquid, that is, not easily realizable. Therefore in the event of a rush on deposits the trickle effort could become a deluge. It is not clear whether the Chinese will have the wits to meet this challenge in a closed economy, resembling a sort of command control style.
The macroeconomic indicators as many of the writers have suggested is not going to evaporate anytime soon. The GDP growth may be 6.0 per cent instead of the official 6.2 per cent. But it is not clear on how the nominal GDP could be just 2.4 per cent when inflation, especially food inflation has not grown in a tearing pace touching double digit figures. Perhaps this reflects mathematical errors?
The Chinese are facing the psychological war from George Soros in their economy; probably a first in their modern economic history. This is something totally alien to them, as they are used only to military threats and confrontations, so far. This will be a war of nerves for the Chinese. It is expected that the Americans will unleash this new weapon in the years to come as part of their Grand strategy for China. They are bound to create a run on the banks. China is certainly vulnerable. George Soros may be a loner for the time being. Others could rush in soon.
Col. R.Hariharan,VSM,
Retired Officer of Intelligence Corps, India.
There are three points to be considered:
George Soros is a seasoned global currency market player, so his views should not be dismissed outrightly. However his talk of hard landing is intriguing.
When China joins global financial order in the short term it can suffer a setback till it gets the back end structure for handling it gets into groove. But it’s good for all of us, particularly for financial analysts riding their hobby horses on China and Yuan. Assessments would be more credible.
The whole issue and its fallout could lead to more transparency internally. So CPC and Xi Jinping will have to cope with greater expectations from the people on greater transparency in opaque governance particularly on minority issues, judicial reforms and criminal justice.
Overall it is expected that China will dominate global headlines because ultimately money matters and China had been behaving like the condescending rich uncle all along.
(All views expressed in this dialogue are the members’ own.)
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