Lessons in Gravity and Intervention; Do Something!

Prop Up Failure

After futile attempts to prop up its stock market bubble, China stood back and did what it should have done in the first place: Let gravity take over.

The Financial Times reports Beijing Capitulates After Spending $200bn to Prop Up Equities.

After spending about $200bn buying shares to prop up falling equity prices over the past seven weeks, Beijing capitulated to market forces on Monday by choosing not to intervene as the benchmark Shanghai Composite Index fell 8.5 per cent.

The fall was the worst since February 2007. But unlike on most other days since the government launched an unprecedented effort to reverse plunging equities last month, the “national team” of state-owned stock buyers did not jump in to support the market.

Beijing’s leaders appear to have belatedly decided it is too expensive and ultimately futile to fight gravity in the equity market, especially as the government is now intervening separately on a massive scale to stop its currency from devaluing further.

Since the People’s Bank of China devalued its currency and introduced a new “market-oriented” foreign exchange price-setting mechanism on August 11, it has had to spend as much as $200bn of the country’s foreign exchange reserves to prevent the renminbi from falling more than it wants, according to people familiar with the central bank and its market interventions.

The scale of the intervention in both equity and currency markets has led many to question whether the Chinese authorities are in control of the situation or whether they have made a series of policy blunders.

“The problem they have now is that they’ve spent as much as $400bn supporting the currency and stock market and they are now worse off than when they started,” said one person with close ties to the PBoC. “I think they got overconfident and underestimated how strong the global reaction would be to the devaluation.”

Swiss Bank Lesson

Please recall the Swiss National Bank effort to prevent the Swiss Franc from becoming too overvalued.

The central bank pegged the Franc near the 1.20 Euro mark and pledged to defend the price at all costs.

But when ECB president Mario Draghi unleashed a huge QE program, the peg became too costly to maintain.

Here was the resultant move.

Wild Swing



click on chart for sharper image

32% Move in 30 Minutes

As the above chart shows, the Swiss Franc soared in value from 1.20-per-euro all the way to 0.82-per Euro but later stabilized in between.

While maintaining the peg, the Swiss central bank accumulated hundreds-of-billions of euros that plunged in price.

Those in countries outside Switzerland with mortgages tied to Swiss Francs immediately saw the amount they needed to pay back soar in value. Many were carted out because they were foolish enough to believe central bank pledges.

China Gravity Lesson

When China pledged to support the stock market, prices stabilized for a while, and traders plowed back into margin.

But today, Chinese central planners finally figured out they could not stop gravity. The ensuing plunge was not orderly to say the least.

What Hath Central Bank Policy Wrought?

The root of the problem in China is loosey-goosey central bank monetary policy that blew a massive property bubble followed by stock market bubble that had millions of high-schoolers opening up margin accounts to speculate.

Global Gravity

The same intervention problems exists in the US, Europe, and elsewhere.

Central bank efforts to "stabilize" everything, led to the exact conditions I described earlier today in VIX "Too Disjointed to Calculate a Value"; Panic Grips Emerging Markets; Biggest VIX Jump on Record.

Gravity has finally taken over. It should have long ago.

Few See Bubbles Until They Pop

I don't know when this will stabilize, nor does anyone else, but if stocks fall to normal valuations, it's a long, long way down from here.

Central bankers will not see themselves as the problem even though they are to blame for the Dotcom mania, the housing bubble, current equity/junk bond bubble, and the income inequality problem that Janet Yellen rails about.

Most fail to see the current bubbles in US equities and junk bonds for one reason only: The US markets have not crashed .... yet.

Do Something!

If there is a genuine crash, as opposed to a slow drip in the stock market for years as happened in Japan, cries will accumulate for the Fed to "do something".

Here's reality: The Fed "already did something". The Fed created this bubble. The only beneficiaries were those with first access to money: The banks, Wall Street, and  the already wealthy.

The middle class was brutally punished once again. Instead of protesting for higher wages at McDonald's people should instead protest Fed policies that steal from the middle class.

Mike "Mish" Shedlock