China - House of Cards?

As anyone who knows me will know, I've long been dubious on China. The numbers are too good, too consistent, too much "on target" and nowhere near volatile enough in a volatile word to be believable - too much like Bernie Madoff in fact.


So to me, the last few days news is not so much a shock as depressingly inevitable. The only real surprises are that the trigger was something as simple as currency liberation and that the moves were quite as violent as they have been, but with the benefit of hindsight the longer it took for the bubble to burst, the bigger the final bursting would be. The inherent contradictions of Communist party control of a supposedly free market capitalist system were bound to overwhelm the status quo at some point.

The more interesting question is what now? It would be hard to put the exchange rate liberalisation rabbit back in the hat - and would kill off any chance of the Yuan joining the IMF list of reserve currencies and forming part of the new SDR basket. And attempts to prop up the equity markets have failed despite the government reportedly spending $200billion in direct intervention and purchases, as well as effectively banning any short-selling, or in some cases even the closing of long positions.

It would seem that events have overtaken the party's attempts to control thjem, and they have now decided to sit back and let nature take its course.

Fortunately equity ownership in China is nowhere near as widespread as it is in the West, but I suspect that those that do own equities are much more highly leveraged, leading to a potential narrow but intense window of pain for a few. It shouldn't have a huge overspill into the broader Chinese economy though, and already the PBOC has taken steps to ease monetary policy by cutting rates 25bp and lowering the banks Reserve Requirement by 100bp to 18% which should mitigate further.

The government is also now attempting to slow the rate of capital flight from the country by cracking down on "shadow banking". The ostensible aim of this is because the shadow banks are illegally helping people take cash out of the country, and this is almost certainly part of the logic of the crackdown, but also reducing the role of shadow banks in the economy inevitably means that the partly government-owned and controlled official banks have a larger role, giving the communist party more control over the economy.

The wider question of course is what happens on the social front. People have grown used to the Chinese government effectively underwriting all their investments. Now a lot of those investments are going to be taking losses. Are the people going to take to the streets to protest? What will the government do if they do (apart presumably from block off Tiananmen Square)? Watch this space....