This. Was. Not. Supposed. To. Happen. (Quoting ZeroHedge.)
Worth noting: in the past few weeks, Chinese government tried very hard to stop the fall and prevent a crash - preventing selling by large stock holders, criminalizing short-selling, ordering stock buybacks, outright buying stocks, relaxing margin requirements, stopping IPOs, ...
Obviously, that's not a viable long term solution.
Is that interventionist policy any different to the Fed and ECB propping up of the US and European stock markets since the depths of the crash with QE? If not then when is the long term viability of that solution going to be called into play?
The Fed and ECB's goal is not to prop up stock market valuations, but to help the economy by encouraging spending and investment through moderate inflation. The banks are tightly bound by inflation targets. Arguably, the ECB has done too little QE since nominal GDP has barely (or hasn't) recovered in most of Europe since 2007, and inflation has been way under target since the crisis.
It seems like China's reaction is more panic-driven, and doesn't have a framework such as inflation targeting to constrain it. In addition, this intervention is just to prop up stock asset prices; encouraging spending and growth in the whole economy is not the primary goal.
With respect to "China's reaction is more panic-driven", check out the following three charts of US Fed policy which I would argue were "panic-driven" based upon magnitude of the intervention when compared historically.
It remains to be seen to what affect recent US Fed policy will do long term, however, I would argue that it was definitely a panic driven reaction.
I provide this not in support of China's policy but for context.
I think the better statement would be that it was a panic, but one with very different and more practical goals.
The US government was primarily trying to keep some big companies and banks that were caught in a liquidity crunch from going bankrupt, because them all going under would likely be a spiraling problem. The crisis solution was also rather simple in aggregate...loan them a bunch of money temporarily until they could free up the assets to repay it.
China is currently trying to prop up a stock market that is STILL (even with today's decline), up 50% in a year for no reason. And most trading in the market is done by very jittery small investors (who are also overleveraged and now desperate to get out) rather than big firms and funds. Said small investors are unlikely to be reassured by anything the Chinese government can possibly do. I don't see great chances for the government to be able to stop this from returning to a more realistic valuation.
Not to mention that I can't imagine how illegalizing trading and other knee-jerk reactions could possibly instill confidence in the market. Even if they can slow the decline, it seems like they'd just enlongate the decline until it reached a similar reality (if their actions don't actually increase the sell-off out of fear).
A lot of economists and market participants believe that these measure not only fail to mitigate falling asset prices but make them worse. For instance, short selling often makes matters worse:
>In 2008, U.S. regulators banned the short-selling of financial stocks, fearing that the practice was helping to drive the steep drop in stock prices during the crisis. However, a new look at the effects of such restrictions challenges the notion that short sales exacerbate market downturns in this way. The 2008 ban on short sales failed to slow the decline in the price of financial stocks; in fact, prices fell markedly over the two weeks in which the ban was in effect and stabilized once it was lifted. Similarly, following the downgrade of the U.S. sovereign credit rating in 2011—another notable period of market stress—stocks subject to short-selling restrictions performed worse than stocks free of such restraints. [0]
Short selling allows market participants to put downward pressure on a security earlier helping the security reach equilibrium faster. Also, allowing the short sale of a stock incentivizes research that bring new less favorable information to public view. For instance, ability to profit off the decline of a stock may result in market participants in uncovering and reporting fraud or helping to pop bubbles.
Often times government interventions and restrictions in the market fuel panic.
For genuine science you'd have to have a control group. "The same group two weeks later" is not a control group.
>Short selling allows market participants to put downward pressure on a security earlier helping the security reach equilibrium faster.
This is story-telling. What happens has more to do with barely sentient flocking behaviour than "reaching equilibrium." There is no "equilibrium" to reach. There are only more or less naive and information-poor actors looking at each other and trying to out-guess the movement of the flock centroid.
It's like running an economy on the basis of a ritualised spot-the-ball competition.
If markets had any real interest in equilibrium or efficiency, bubbles wouldn't happen. But markets don't - mostly they have an interest in short-term gain, which makes the whole system as predictably unstable as any other system driven by positive feedback.
Of course some agents profit very nicely from bubbles, and politically bull markets are a useful way to create an illusion of shared prosperity. So it's in their interests for the manic-depressive nonsense to continue.
I agree with your story-telling perspective. No one knows "why" the market is down. There may not even be a reason or may be unknowable. All the reason that you should let prices adjust accordingly with minimal intervention because most interventions will have unintended consequences.
Maybe the second part of my sentence about short-selling was a bit of a reach, but short selling does provide downward pressure on prices which would (in theory) more accurately reflect the actual value based on what other market participants are willing to pay for it.
Prices are not arbitrary and are the best way to convey information. Trying to control markets by controlling prices is like trying to control the weather by controlling thermometers.
My personal theory is that disallowing short selling makes finding a bottom that much longer and tumultuous. Why? Because shorts need to buy to close out their positions. If you ban shorting, you have taken a large pool of buyers out of the market. You know that the only buys are those people dipping toes into the water. If you have shorting, you don't know if those are people dipping toes, closing out shorts, or someone getting ready to take a large position. It puts the healthy uncertainty back into the market, but this time in the mentality of making short sellers fearful. Fearful of a squeeze. That's what I've seen over my market experience (20 years trading, 15 years trading my own portfolio).
Buyers of a stock know that a restriction on short selling is most likely temporary. So if they buy now, as soon as the restriction is lifted, they can guess that the stock price will go down. So why not wait until things have returned to normal?
Maybe that was the goal of banning short selling - to get the market to take a longer time to go down, so people wouldn't panic and the transition would be smoother.
Worth noting: in the past few weeks, Chinese government tried very hard to stop the fall and prevent a crash - preventing selling by large stock holders, criminalizing short-selling, ordering stock buybacks, outright buying stocks, relaxing margin requirements, stopping IPOs, ...
Obviously, that's not a viable long term solution.