08.31.2015 1

Is China propping up the U.S. stock market?

By Robert Romano

chinese tigerLast week, global equity markets were tanking in the midst of a major correction, largely in response to what was happening in China where stock markets are down nearly 40 percent since they peaked in June.

Then, suddenly, it stopped. U.S. markets rebounded, and soon it appeared the panic had abated. What changed?

Chinese government intervention. In addition to the yuan devaluation, China has stepped in to cut interest rates, inject liquidity into financial institutions, and perhaps most importantly, outright purchase of stocks on the market by the People’s Bank of China.

This, writes Marketwatch’s Chao Deng, has temporarily ended the selloff: “Rumors of Beijing’s hand in the market reversed the selling by Thursday, which helped support global shares prices, commodities, and currencies of emerging markets that had been battered.”

Yet, should Chinese markets begin getting hammered anew, despite the government intervention, it might reignite the global panic.

It all poses an interesting question. Once global equity markets become addicted to easy money from central banks, will there ever be any way to break the addiction?

According to the World Federation of Exchanges (WFE), the total value of equities worldwide fell from a high of $56.8 trillion in May 2008 to $42.9 trillion in Sept. 2008. By the end of 2008 it was $32.8 trillion. And in Feb. 2009, it had dropped to a low of $29.1 trillion.

In less than a year, over $27.7 trillion of wealth was erased.

Since that time, there has been a considerable recovery. In May 2015, global stocks peaked at about $70.8 trillion, up 143 percent off its 2009 lows.

Meaning, equities markets were long overdue for a correction.

And yet, central banks, like China’s, may not be willing to allow that happen. But why not?

A hint may come from none other than former Federal Reserve Chairman Ben Bernanke — then a professor — commenting in 2000 on Japanese policies after their housing bubble popped in 1989. That was when he advised corporate bond and equity purchases to prop up Japan’s economy in an environment with near-zero interest rates.

Bernanke explained the rationale, quite simply, would be to raise prices. “The object of such purchases would be to raise asset prices, which in turn would stimulate spending.”

Vince Reinhart, then Fed Director of its Division of Monetary Affairs, at the Federal Open Market Committee (FOMC) meeting in June 2004 described the circumstances under which a central bank might engage in such purchases: “if the policymakers believed that deflationary forces were severe.”

Reinhart also dismissed the possibility at the time, saying, “These options would change how we are viewed in financial markets, involve credit judgments of a form we are not used to, perhaps smack of desperation, and pull us into a tighter relationship with other parts of government.”

Recall the circumstances Reinhart outlined for central bank purchases of stocks: “if the policymakers believed that deflationary forces were severe.”

With the People’s Bank of China actively intervening with stock buys to prop up not only Chinese markets, but global equity markets, that may mean that top policymakers there believe that deflationary forces are severe enough to warrant intervention. That would be an extremely bearish indicator.

Consider that prior to the run up of China’s equity markets, it had just experienced a massive property bubble. Falling asset prices, therefore, is a real concern.

And where it stops is anyone’s guess. How long before the People’s Bank of China capitulates, and allows markets to find their bottom? The longer the intervention continues, the greater the costs of withdrawal will be.

In the meantime, it appears very much like the only thing propping up global equity markets at the moment is the People’s Bank of China. And that should be a very troubling thought for investors and observers alike.

Robert Romano is the senior editor of Americans for Limited Government.

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