Chinese Yuan Falls After Another Chinese Market Crash

How is anyone surprised at another China stock market crash? Chinese regulators have consistently overplayed their hand in trying to calm markets, spelling the likelihood of possibly more losses for the Chinese yuan in 2016. The second Chinese market crash this week was all but guaranteed.

Now I want to be clear here: none of this should be taken as a reflection of the broader Chinese economy. When people talk about a supposed failure of China’s economy, they are speaking in relative terms. The country is still forecasted to grow by 6.5% in 2016. (Source: “China Stocks: Trading Called Off for Second Time This Week,” Wall Street Journal, January 7, 2016.)

That may be lower than previous years, but it doesn’t exactly sound like a disaster. In fact, we knew this was coming. All developing countries face a period of rapid expansion before paring back growth to a more sustainable rate. That’s basic economics.

However, the stock market has been more volatile, in large part because of a series of policy missteps. The fear instigated by a series of boom and busts in the Chinese market has deepened worries of a slowdown and forced the central bank into an uncomfortable position. They must continue to devalue the yuan in order to prevent capital flight.




China Worries Can’t be Brushed Aside

For the second time this week, trading was suspended on China’s stock market. The “circuit breaker,” an automatic kill switch embedded by regulators, kicked in after Chinese equities lost seven percent of value. What caused this particular stumble?

To put it simply, investors are afraid. I know that answer is unsatisfying, but consider the following sequence of events. Every time Chinese officials have made a regulatory change in the last year, it has wreaked havoc on the market.

In the summer of 2014, the Shanghai Composite Index (which tracks all major Chinese stocks) began a spectacular 12-month bull market. After 150% in gains, Chinese regulators were worried about excessive leverage in the stock market, so they tried to reinstate old rules against margin trading.

The effect was disastrous, leading to an epic stock market crash in June and July of 2015.

In a desperate attempt to stem the bleeding, officials relented on the margin trading ban, letting the flow of credit resume. However, they kept in place some emergency measures, such as forcibly preventing institutional investors from selling their stakes in Chinese firms.

They literally banned institutional investors from selling their shares. The ban was supposed to last six months, which means it was nearing its expiry date. Investors were afraid of a mass exodus once the ban was lifted, and the enactment of a “circuit breaker” only cemented those fears.

That’s why we saw a crash at the start of the week.

Yuan to USD Losses Accumulate

Since then, Chinese officials had to remove the circuit breaker, publicly consider an extension on the institutional investor ban, and slash interest rates to devalue the yuan.

China’s aggressive actions pushed down the onshore yuan by more than 1.5% for 2016, while the offshore, and more freely traded, yuan, fell by 2.7%. (Source: Ibid.)

China’s openness to a weaker yuan has taken many observers by surprise. It is read as an admission of deeper economic woes and any forceful action is considered an attempt to paper over that admission. Further losses are widely expected.