China Fears Trade War, PBoC Chief Yi Gang Says Market Stable

After the Chinext fell to a new post-2015 low and the Shanghai Composite hit slid 3.78 percent to a new 52-week low, PBoC Chief Yi Gang gave an interview to Shanghai Securities News.

Aside from signaling there's concern for the markets, the interview also tells us what is driving official concern: trade war. Trade only looks like the icing on top of a bearish picture though. Investors had three days to digest the threat posed by The Bubble's Revenge: China's A-Share Market is Littered With Pledged Share Land Mines Buried During 2015 Mania. They have been worried about pledged shares hitting the market as borrowers defaulted on loans.

They were also worried about a technical breakdown in the market (Chinese investors rely more on technical analysis than U.S. investors). I posted an article Darkest before Dawn or Sun Still Setting: Shanghai Comp Loses 3000 yesterday. The Chinese article referenced in the post argued the market was nearing a bottom, but that it might be "darkest before dawn." By the time I put it up, President Trump had announced he wanted more tariffs, but that article was up on the Chinese site before 8 AM Beijing-time and it had to be written at least hours earlier, if not the night before. In other words, investors in China were ready for a market drop or a test of the Shanghai Composite's 3000 level before the news hit. No doubt the tariff news rattled the market, but that's only one part of the story.

PBoC: 易纲行长接受《上海证券报》采访

Shanghai Securities News: President Yi, the Shanghai Composite Index fell 3.78% today. What do you think? ??

Yi Gang: First, financial market fluctuations are affected by many factors. Today's stock market fluctuates and is mainly affected by emotions. The surrounding stock markets have also experienced a certain degree of decline. Since it is a market, there will be ups and downs. Investors should stay calm and rational.

Absolutely true. The percentage is a bit large compared to U.S. markets, but China should be a more volatile market.

Second, China's current economic fundamentals are good, the resilience of economic growth has increased, the total supply and demand have become more balanced, and the growth momentum has been accelerated. This year, the renminbi is one of the few currencies that have appreciated against the US dollar. Based on such economic fundamentals, China’s capital market is in a conditional and healthy development. I am full of confidence.

The renminbi strengthened because of capital controls and possibly because China fears if they let the yuan depreciate as it should, the trade war will intensify. The rest is either true or narrative, depending on how you view it. China's macro economy didn't suddenly deteriorate on Tuesday.

Third, in recent years, domestic demand has driven the Chinese economy to increase. The degree of dependence on trade has dropped from 64% in 2006 to 33% last year. It is lower than the world average of 42%. The current account surplus also accounts for the proportion of GDP. In 2007, about 10% fell to 1.3% last year, and our economy’s ability to cope with external shocks has continued to increase. China is a big market with a population of more than 1.3 billion. The economic endogenous potential is huge and there are sufficient conditions and space to deal with various trade frictions.

I don't like the sound of this at all. Maybe he's bad at public relations, but it is bad news when the central bank starts talking about its current account. That suggests serious concern on the part of the central bank, markets, or both.

Fourth, the People's Bank of China has always attached great importance to the impact of external shocks. We will proactively make relevant policy reserves, comprehensively use various monetary policy tools, maintain reasonable and stable liquidity, and grasp the strength and rhythm of structural deleveraging to promote The economy develops steadily and healthily, and the bottom line of systemic financial risks does not occur.

The 19th National Congress of the Party has made full arrangements for the next step of reform and opening up. China will continue to unswervingly deepen reforms and expand openness. Reform and opening up will benefit China and the world.

Was the stock market falling because of trade fears or because of pledged stock landmines and deleveraging efforts? My tracking portfolio of Chinese stocks with heavily pledged shares fell 6.92 percent on Tuesday. How big a role trade played in the market drop on Tuesday, officials are clearly concerned about trade. And they're pushing the narrative of the strong renminbi. China has to keep the renminbi from depreciating. A rising dollar will trigger reflexivity that drives the dollar ever higher and the yuan lower, but it will also create narrative reflexivity as a falling yuan reveals weakness in China and investors turn more negative.

Chinese officials aren't demigods. The PBoC is one of the smartest, if not the smartest central bank in the world. It has the most policy levers of any major central bank. And yet, even it is subject to market forces. It's $3 trillion in reserves are spoken for many times in the supply of money and credit. China is not in a good position to fight a trade war and, whether I'm right or wrong about the U.S. intentionally puling China into the trade trap for geopolitical reasons, I doubt China cango more than a couple rounds of escalating tariffs before the dominoes start falling.

In conclusion, the tumble in Mainland markets was not because of the escalating trade war. It was a factor, but Chinese investors were already on edge because the market was threatening to break long-term support. There were serious concerns about defaults on loans backed by stock pledges. The decline in trade relations didn't help, but it is only one part of a much larger macro picture. Weakening growth, a rising U.S. dollar and deleveraging efforts have been chipping away at the markets. China has prevented the dominoes from falling before, but a trade war with the United States is one domino they have no control over. As I warned years before, China was running out of room to reform. As the supply of money and credit expanded, the room for error decreased. The threat of an external shock increased. The threat of trade retaliation was always rising as social mood declined around the world. If social mood continues to decline, "negative" (narrative) and negative (for real) events will hit with more regularity.