Originally published on Forbes.com
by Gordon Chang
Saturday, the People’s Bank of China released a statement on its website seeking to calm the country’s stock and currency markets and reassure the international financial community. The central bank’s posting, on the eve of the resumption of trading after a two-day holiday, contains Governor Zhou Xiaochuan’s first public words directed to the Chinese public on the stock plunge, which began mid-June, and on Beijing’s all-out response.
Zhou’s statement is in many ways remarkable. The central bank, by issuing its unprecedented opinion on the condition of the markets, has created a test of its credibility—and, by extension, a test of the credibility of the Chinese central government and the Communist Party. Price movements this week will undoubtedly tell us much about the direction of China’s markets over the next several months.
Zhou, in comments summarized by the central bank, said the “correction in the stock market is almost done.” He also predicted an end to volatility, saying the market will become “more stable.”
These words provide the context for his repeated references last week, at the G-20 meeting in Ankara, that the Chinese stock market bubble had “burst.” Now, it is clear he believes that, because share prices have just about bottomed out, intervention is no longer needed.
The People’s Bank of China, run by technocratic reformers like Zhou, has never liked the effort to keep stocks at abnormally high levels, as Premier Li Keqiang demanded in early July with his emergency rescue program. Yet Zhou’s PBOC reports to Li’s State Council and had no choice but to implement the interventionist effort.
That program worked at first to stem losses, but it began to spectacularly fail in mid-August, when shares resumed their downward path.
Since then, intervention has not pushed stocks to the government’s announced price target, 4,500 points on the widely followed Shanghai Composite Index. The index closed at 3,160.17 on Wednesday, the last trading session before the two-day holiday to commemorate the end of the Second World War in the Pacific.
Zhou has now given his view on stock prices. Last week’s price movements, unfortunately for him, do not lend support to his views.
Last week, the Shanghai Composite fell 2.2%, losing ground all three trading days. Beijing’s so-called “national team” of state enterprises, entities, and funds apparently engaged in substantial late-session buying.
There was also some afternoon buying in Shenzhen, probably by Beijing. There, the main index dropped 9.4% during the three trading days last week. Shenzhen’s Nasdaq-like ChiNext also ended the week lower, off 12.5%. Neither index had an up day last week.
Trading patterns suggest heavy government support in Shanghai and limited intervention in Shenzhen, and at first glance this contradicts Zhou’s pronouncements that stocks are close to their bottom. And common sense also tells us he is wrong. After all, stocks began their extraordinary ascent—soaring more than 150% in less than a year—almost entirely because of a reckless Communist Party decision to talk up stocks. A year ago, the Shanghai Composite bounced around the low 2,300s.
That’s why analysts predict a return to that level. Yet those forecasts are optimistic. Then, the economy was in far better shape than it is today. At the moment, growth is probably no more than the 2.2% that many in China privately mention.
Moreover, China’s most pressing issue—capital outflow—has obviously increased since then. Wind Information, the Chinese financial data provider, in late August reported that outflows from China exceeded inflows by 2.6 trillion yuan, about $405 billion, in the preceding three months.
Stocks evidently want to move downward, but the central bank is nonetheless determined to end intervention. That admirable intention is evident not only from Zhou’s Saturday statement but also from comments from Fan Gang posted Thursday by Southern Metropolis Daily, the Guangzhou newspaper. The well-known economist called the central government an “exceptionally negative factor” influencing stock prices and debunked the idea that Beijing is moving the markets. He termed that notion “bankrupt.”
Fan’s astonishing words, wrote Xie Yu and Liz Mak of the South China Morning Post, “indicated a new gulf has opened up publicly in top policymaking circles on the sustainability of long-term state support for China’s faltering stock market.”
Roger that. Fan is no mere celebrity technocrat. He sits on the central bank’s Monetary Policy Committee and is sometimes thought to be an indicator of thinking in reformist policymaking circles.
Not every Chinese official is brave enough to let the market operate on its own, so Zhou is especially forward-thinking. He can adopt a bold stance largely because he seems to believe the worst has passed, and now he has staked the political fortunes of his institution on future stock movements.
If stocks advance, he and the PBOC’s other reformers will be on solid ground.
If stocks retreat—far more likely given fundamentals and the mood in China—he and the bank will be blamed. The window for reform will then close.
So give Zhou Xiaochuan credit for laying down a marker. We will soon see if China’s investors have regained confidence in their economy and their government.