Indeed, one of the fears expressed in relation to the Chinese rout has been the ineffectiveness of much of the initial policy interventions.
Investor faith challenged
As Bank of America Merrill Lynch explained it on Thursday, the biggest damage caused by the A-share market’s roller-coaster ride since the middle of last year has been to investors’ faith in the government’s ability to manage asset prices (stock, RMB, debt and even property) reasonably smoothly.
It said: “The difficulty the government has faced to stabilize the stock market has demonstrated the downside of that faith. As a result, we expect many of these assets to be re-priced lower going forward. Also, the ripple effect from the market correction has yet to show up – we expect slower growth, poorer corporate earnings, and a higher risk of a financial crisis.”
A more pessimistic view of this increasing reliance was expressed recently by strategist and keeper of the Library of Mistakes, Russell Napier, who told Brewin Dolphin’s head of research Guy Foster that there is a great deal of belief that central banks will find a way out of this and anything that shatters that belief has implication for all growth assets.
Speaking on the Brewin Dolphin podcast, Napier said the biggest mistake made in relation to China is to analyse it as if it is a market economy – it may be part way there, he said, but it is not an market economy.
“When you control the banking system, when you control just about everything, you can live in a world of misallocated capital for a prolonged period of time,” he explained, “Most wise economists forecasted the collapse of the USSR from about 1948 onwards and they were, ultimately, correct, but it took 40 years.”
For Napier, while one can ‘buck the market’ for a long period of time, what is harder to get away from is the exchange rate. And, now that Chinese currency is linked to a strong currency, in the form of the US dollar, he says, it has a simple choice to make, either it will keep its currency strong, which will lead to internal deflation or it can devalue, print money and let the economy grow.
Napier expects China to do the latter. But, with that comes something else – deflation.
“If China were to devalue it would sell goods cheaper in $ terms and almost certainly most places would find themselves with deflation and the question would then be, after six years of QE, do central bankers really have all the answers. If the markets ever conclude no, then there is fairly significant downside for equity markets.”
Another implication of this he says, is that if monetary policy in the West is unsuccessful at reflating the economy, there are very limited ways to deal with excessive debt levels, but one way would be to move it from the private sector to the state.”
This, he says, is a longer term worry – most people fear that the current interventionist monetary policy will ultimately lead to an eruption of inflation, but there is a chance it erupts in more government control.
“The markets may not be perfect at allocating capital but I am afraid this monetary policy takes us into a world where governments get more involved in allocating capital. There are lots of flaws in the markets, and we can change them, but, partially because market participants aren’t very good at being proactive, I am afraid we could see something much worse.”
