China can circuit-break its way back to order
Critics have raised red flags over China’s newly-mooted circuit breakers, arguing that the answer to state intervention in its stock market should not be more state intervention. The plan comes at an uneasy time, but is one that will work in China’s favour in the long run.
Last week saw China make another attempt to bring some calm to its stock markets, as the Shanghai, Shenzhen and futures bourses sought to create a set of circuit breakers.
According to the proposal, trading will be suspended on all three exchanges if the CSI 300 index swings 5% or 7% on either side. On top of that, there will be a 30-minute freeze if the index rises or falls by 5%, and an all-day suspension if it touches 7%.
Naysayers have derided the proposal as heavy handed, an affront to China’s pledges to reform its financial markets and a way to tighten the screws just when the market was seeing a real chance of recovery. But to take such a view would be incredibly short sighted.
There’s no denying the state went in too early and too eagerly to prop up stock prices after they fell from grace in July. Since then it has put IPOs on ice, punished short-sellers and pumped money into the market in a bid to reverse the slide.
Now its latest intervention comes in the form of an index-linked circuit breaker. If nothing else, it was born out of the realisation that its policy options were becoming limited, with successive rounds of monetary easing losing their spice.
Stimulus is no longer having the same effect it used to, so China has decided that a set of circuit breakers would be the best way to keep crazy stock movements at bay.
And that kind of forcefulness is exactly what the market needs. Retail investors are momentum investors, as the recent crash has shown. Curbing their investment urges is critical, if only to bring stability onshore if China wants to further loosen capital controls.
In this debate, institutional investors have been the most vitriolic, likening circuit breakers to a sword of Damocles hanging over every trading decision. A bourse-wide suspension would only serve to kill already tepid trading volumes, they argue.
At the same time, it is those same institutional investors who would be the first to get back into the market at the first signs of stability as China is simply too big an animal for them to ignore.
And the new circuit breakers could provide that stability, especially as the triggers for the CSI 300 seem sensible. Over the past decade, swings of more than 5% in Chinese stocks have only really been observed in 2008 and 2013.
And even though such movements have been frequent this year, the possibility of having their fingers burnt means investors’ self-preservation instincts will kick in in the future when the index gets close to hitting the triggers.
More crucially, circuit breakers are not a novel feature. Mature markets like the US possess a market-wide circuit breaker, first triggered at 7%, to stem any outbursts of panic selling. That China is implementing its own brings it in line with international market practice.
With the proposed circuit breakers, China has not taken its eye off target. It wants, and needs, to temper the incredible volatility that has beleaguered its own stock market and created a domino effect globally.
Proponents of a free market have often called for less, not more, state intervention, and for the market to find its own level. But at what cost? Given its size, that would be a scary prospect for China.