Why The Chinese Market’s ‘Circuit Breaker’ Doesn’t Work

It’s the market, it’s China

We are only beginning the new year and we have already run into a big problem with the Telstra stock. No, it is not the fundamentals of the stock. It is the whole Aussie market which Telstra is part of, it is China!

The biggest risk in the world is China. Overnight, the government removed the ‘circuit breaker’ that caused two trading halts this week.

By last night, we all knew that the circuit breaker does not work, because it arguably caused the Chinese market to hit its ‘stop-loss’ level within 15 minutes on Thursday.

The circuit breaker does not work because it prompts people to just line up and panic-sell their positions on the following morning.

So the score is: market democracy 1, government interventionism 0.

The Chinese government cannot stop what the market wants to do, they have to learn that. The government is still going about it the old way, what Chinese call ‘the Chinese way’, which is hard-line, punishment-driven management.

The market is going to do what it chooses to do. Capital is democratic, it does not matter what the government does.

The biggest risk in the world is China’s financial reform risk.

I have told New Frontier Investor readers that 2015–2016 will be a pivotal time because of the rise of China. That is ‘unfortunately’ true.

I also told the readers that the problem is not with free-market economics, it is the sort of partially-free, ill-priced, planned-economy structure that China operates in.
This results in ‘behind-the-door’ policy-making.

Let me quote Deng to demonstrate the mentality of the regulators. When China first started its own stock market, Deng said in an internal conference: ‘We should try out this stock market. If it doesn’t work, we can always shut it down.’

I cannot stress enough how important politics and policy-making are in China. On a higher level, it is not about economics in China, it is about power, political rivalry and military control.

We see that sort of hard-line mentality in full swing in China this week, with them going back-and-forth with their decisions, trying to dictate what essentially is uncontrollable.

And you can be sure that they will continue to deliver surprises to the markets. Only now what they do has global ramifications.

The Chinese financial regulators are managing a number of reforms at the same time. first is the economic rebalancing from manufacturing to consumption. Second is currency reform, pushing the yuan to the wider world by letting in market forces. And third is capital market reform in equity markets and debt markets (the debt market is a problem in itself).

The problem now is the three areas are undermining each other. The currency reform sees the Chinese regulators wanting to move away from the loose-peg to the US dollar, and to make the yuan reflect more of market forces.

Market forces say down with yuan and out with capital flow. So the regulators drain the reserve to defend the yuan.

The target of the regulators in the short run is more depreciation against the US dollar to reflect market forces. Over the long run, growth and additional demand for the yuan should see it strengthen.

However, the problem occurs when a more-than-expected depreciation of the yuan hits global market sentiment. That has a ramification on the stock markets, including China’s own.

Ken Wangdong

Emerging Market Analyst, New Frontier Investor

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