China Is Now Threatening Stock Market Investors With Arrests

Watching Chinese authorities scramble to fix the stock market is something of a guilty pleasure of mine. That’s not to say I take satisfaction from the mayhem overwhelming the markets. But it’s fascinating to see regulators come up with creative new schemes to prevent the flood of selloffs.

At first, measures aimed at stemming the losses seemed warranted. Chinese markets were losing the equivalent of $150 billion every day. In three weeks, markets have shed $3 trillion off their market cap. That’s roughly the equivalent of two Australian economies.

As these losses have accumulated, the authorities have become increasingly desperate. And their desperation took on a whole new meaning overnight.

In a remarkable twist, authorities are now investigating what they term ‘malicious’ short sellers, with a view to making arrests.

Short selling is a speculative instrument by its very nature. It involves borrowing shares from lenders, then selling them back onto the market. But the trick involves knowing whether or not the price of those shares will decrease. In China right now, it’s easy to predict their trajectory.

When prices fall, traders can buy back those shares, and resell them to the lender, pocketing the difference. It can be very profitable. But it can also aggravate an already stricken market, as it’s doing now.

Yet that shouldn’t give authorities the power to arrest short sellers. Threatening investors with a trip to the jail cell seems excessive, if not immoral.

That means that, for the time being, the legality of short selling remains up in the air. Authorities can reassure the markets all they want, but where will they draw the line? What constitutes it as illegal behaviour? In a market that’s crashing as China’s is, the question of legality seems altogether irrelevant.

After all, the primary aim of regulators is to stop the markets from sliding further. It certainly isn’t to clean up any dodgy trading practices. For that reason, every short seller will think twice about any move they make.

In a country shrouded in secrecy as China is, this development is very worrying. It opens up serious questions about the future transparency of Chinese stockmarkets.

China has been desperate to get added onto MSCI’s World Index. But these measures aren’t going to help their cause. MSCI wants to see regulatory transparency, not state interference.

The threat of social unrest

Yet, while the government is acting desperately, they’re not stupid. In any other developed economy, this measure would be scandalous. In China, it’s something we’ve come to expect.

China has a long history of mistrust between the leadership and its people. Preventing social unrest has been the number one goal of Chinese rules for centuries.

One of the ways they’ve managed this in recent decades was to promise everyone greater personal wealth. For a long time, China’s prosperity has worked in keeping everyone occupied.

From jobs to houses, the average Chinese person is far richer than they were even 20 years ago.

But with housing growth tapering off, the next great promise was in stocks. It’s now three years since the asset really took off and a hard landing appears all but certain.

Should the markets continue their slide, it could create political instability. That may make it harder to contain the social unrest that could arise as a result.

That’s why they can threaten short sellers with arrests. There is no step too far when the stability of an entire nation is at stake.

How the markets reacted

Any rational observer is likely to agree that arresting short sellers is absurd. It’s not only totally unnecessary, but it should have sent the wrong message to markets.

Well, it should have; but it didn’t.

Chinese investors are obviously as desperate as regulators are to stop the rot at this point. Anything which temporarily halts the selloffs is reason enough to celebrate.

So investors took the bait.

The Shanghai Composite Index closed 5.8% higher on the back of the news. Just prior to this news leaking, it had fallen to a four month low. This rebound was the biggest one day rise on the SCI since March 2009. The large cap CSI 300 index also closed 6.4% higher.

Meanwhile, regional markets reacted gleefully too. Japan’s Nikkei 225 closed 0.60% higher, having fallen by as much as 3.2% in earlier trade.

Even Europe, with its very own melodrama to contend with, rose on the uptick across Asian markets.

Unfortunately, the feel-good factor didn’t spread to Aussie markets. The ASX 200 was largely unmoved. The falling iron ore prices offset the positivity coming from China.

So it seems as if Chinese authorities got something right. If investor confidence is up, then they must be doing something right, no?

Well, threatening anyone with potential arrests is going change the way people behave.

However, I doubt that this will be the case in the long run.

I suspect this will be nothing more than a short term reaction to the volatility taking place. It’s a brief respite that’s not likely to have positive long term consequences.

It may stop short sellers from speculating briefly. But it won’t change the broader outlook for Chinese stocks.

The timing of the announcement also suggests that authorities are serious about following through on their threats. They clearly wanted markets to end on a high for the week. It’s left investors with an entire weekend to ponder their next moves.

The message is clear: stop selling, or a jail cell awaits.

The laundry list of desperate regulations

The threat of arrests may be the most extreme measure, but it’s by no means the only one.

One measure that slipped under the radar has been a ban on shareholders selling stock. Directors and executives, with stakes of more than 5%, will be unable to offload their stocks for six months.

You could easily make a case for this ranking right alongside the threat of arrests in the sphere of regulatory absurdity.

And that’s not all. In the past several weeks, Chinese authorities have:

  • Suspended share for over 1400 listed companies
  • Heavily reduced margin requirements to keep margin traders from selling
  • Allowed properties to be used as leverage
  • Stopped reviewing new IPOs
  • Blocked fund redemptions, to force companies to invest in the share market
  • Lowered equity transaction fees

All these measures have had positive short term effects. But that’s all they’ve been — short term. The broader trend is still one of a market in terminal decline.

No threat of arrest is going to change that.

Mat Spasic,

Contributor, Markets and Money

PS: Chinese authorities are panicking as the market continues its inevitable slide. The fallout of a total market crash will have major repercussions for Aussie markets. Anything which threatens the health of the Chinese economy will come as a big blow to the Australian economy. That would only speed up Australia’s own stock market bubble popping.

Markets and Money’s Vern Gowdie sees a major correction across the ASX in the future. Vern is the award-winning Founder of the Gowdie Family Wealth advisory service. He’s been ranked as one of Australia’s Top 50 financial planners. He believes we’re set for a catastrophic crash in stocks in the future. And he thinks the ASX could lose as much as 90% of its $1.8 trillion market cap.

Vern wants to help you avoid the coming wealth destruction. That’s why He’s written ‘Five Fatal Stocks You Must Sell Now’. In this free report, he’ll show you which five blue chip Aussie companies could destroy your portfolio — and you almost certainly own one of them. To find out how to download the report, click here.

Join Markets and Money on Google+

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

Leave a Reply

Your email address will not be published. Required fields are marked *

Markets & Money