What policies can stabilize the market?
CHINA FINANCIAL - In Brief 08 Jul 2015 by Michael Pettis
We must avoid the tendency to think of interventions aimed at stabilizing markets as being independent of the structure of the market. In my Peking University seminar I warn my students that because most of the world’s leading economists have been directly or indirectly trained in a tradition that French social scientists, although not French economists, refer to ominously as “Anglo-Saxon”, there is a tendency for us, even Beijing policymakers, to default automatically to an American or British context. The Chinese stock markets however operate under very different conditions. In a speculative market with few value investors, policies aimed at boosting prices by increasing the present value of discounted future cashflows are largely irrelevant. Given economic expectations that were already weak, and can only have been weakened further after the events of the past few days, prices are still far too high to justify purchasing on value unless interest rates drop much further. This is why I am not especially impressed by policies, like interest rates cuts or attempts to cut the cost of stock purchases, that are implicitly aimed at encouraging value investors to step up their purchases. We know that increasing the economic value of expected cashflows can cause speculators to step up their purchases, but it is important to understand why. Speculators will purchase in response to policies directed at increasing economic value only if they anticipate a consequent increase in buying by value investors.
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