cooling the Chinese stock market fever

In the 1990s, Alan Greenspan, the head of the Fed back then, famously warned against “irrational exuberance” in the US stock market, but did nothing to stop it   …this even though he had the ability to cool the market down by tightening the rules on margin lending.  This is the stock market  analogue to raising or lowering the Fed Funds rate to influence the price of credit, but has never been used seriously in the US during my working life.

The  Bank of Japan has no such compunctions.  It has been very willing to chasten/encourage speculatively minded retail investors by tightening/loosening the criteria for borrowing money to buy stocks.


We have no real history to generalize from in the case of China.  But moves in recent weeks by the Chinese securities markets regulator seem to indicate that Beijing will fall into the stomp-on-the-brakes camp.


–at the end of last month, the regulator allowed (ordered?) domestic mutual funds to invest in shares in Hong Kong, where mainland-listed firms’ shares are trading at hefty discounts to their prices in Shanghai

–highly leveraged “umbrella trusts” cooked up by Chinese banks to circumvent margin eligibility requirements have been banned,

–a new futures product, based on small and mid-cap stocks, has been created, offering speculators the opportunity to short this highly heated sector for the first time, and

–effective today, institutional investors in China are being allowed to lend out their holdings–providing short-sellers with the wherewithal to ply their trade (although legal, short-selling hasn’t been a big feature of domestic Chinese markets until now, because there wasn’t any easy way to obtain share to sell short).

What does all this mean?

The simplest conclusion is that Beijing wants to pop what it sees as a speculative stock market bubble on the mainland.  It is possible, however, that more monetary stimulus–to prop up rickety state-owned enterprises or loony regional government-sponsored real estate projects–is in the pipeline and Beijing simply wants to dampen the potential future effects on stocks.

I have no idea which view is correct.

It’s clear, however, that Hong Kong is going to be a port in any storm, and that it is going to be increasingly used as a safety valve to absorb upward market pressure from the mainland.  So relative gains vs. Shanghai seem assured.  Whether that means absolute gains remains to be seen, although I personally have no inclination to trim my HK holdings.



speculation: stabilizing or destabilizing?

In the Panglossian world of academic finance, all markets are self-regulating and all participants are rational economic agents with the same information and motivations.

Commodity trading, where there are two different classes of market participant, with different knowledge levels and goals, really doesn’t fit in this model,.  On the one hand, farmers and miners, who are typically large corporations, want to guarantee a minimum level of cash flow for their operations.  They do so by selling a certain portion of their output for future delivery through any of a variety of kinds of commodity contracts.  The firms are deeply knowledgeable about the products they produce and sell, and they employ highly paid professional traders to do their commodity trading.  These are the hedgers.

And then there’s everyone else.

An obvious question is why someone would take the other side of the hedgers’ trades, given their superior information and high degree of trading skill.  Clearly, however, someone does, since we know that companies are routinely able to hedge their output.  Academics call these counterparties speculators.

To the academic world, it follows that speculators are a stabilizing influence.  They help to regularize the cash flows of potentially highly cyclical companies; commodities futures/forwards prices would also be higher than they are if speculators didn’t step in to take the other side of the hedgers’ trades.

In its most basic form, that’s the academic theory.

One trouble with the theory is that it’s just a generalization of the way commodities markets worked a generation ago, mixed in with the semi-religious belief in an “invisible hand” that ensures a favorable outcome in economic affairs. Worse, the basic metaphor no longer fits the facts–if it ever did.  Two examples:

1.  the silver market.  The broadening of commodities trading access to large numbers of private individuals, and the rise of commodities-oriented ETFs that give indirect access to a larger, less-affluent group, mean that some commodities markets are no longer dominated by hedgers. The “other guys” are now running the show.  And their recent behavior in silver is, to my eye, anything but stabilizing.

2.  the oil market.  Oil is an extremely economically important commodity.  Demand is highly inflexible.  Supply and demand are finely balanced.  As a result, it’s possible for speculators–whether private individuals, hedge funds or the commodity trading arms of commercial and investment banks–to be only a small fraction of all trading but still exert enough upward pressure on prices to make them, say, 10% higher (or lower) than they otherwise would be.  Prices might be stable in the sense that they don’t fluctuate much.  But a movement of this size means a major redistribution of wealth around the world.  Great for oil-producing countries, not so hot for everyone else.

In these instances, at least, speculators are a destabilizing force.

The recent ad hoc action of commodities exchanges in raising margin requirements appears to have pricked speculative bubbles in a number of commodities.  But I think it would be better for all of us if we had better regulation and a coherent framework for action.