China has created some amazingly successful futures markets in recent years. By contract volume, the top 5 ag futures are traded in Zhengzhou, Dalian, or Shanghai, as are 4 out of the top 5 metals contracts. Once upon a time, China also had the most heavily traded equity futures contracts. Once upon a time, like two months ago.
Then the crash happened, and China thrashed around looking for scapegoats, and rounded up the usual suspects: Speculators! And it suspected that the CSI 300 Index and CSI 500 Index futures contracts were the speculators’ weapons of mass destruction of choice. So it labeled trades of bigger than 10 (!) contracts “abnormal”–and we know what happens to people in China who engage in unnatural financial practices! It also increased fees four-fold, and bumped up margin requirements.
The end result? Success! Trading volumes declined 99 percent. You read that right. 99 percent. Speculation problem solved! I’m guessing that the fear of prosecution for financial crimes was by far the biggest contributor to that drop.
The stock market (led, as is usually the case, by index futures) was bearing bad news, so the Chinese decided to shoot the messenger. Then back over it a few times with a tank and bury it in cement. Just to make sure.
There is a wider lesson here. Namely, China may talk the reform talk, but doesn’t walk the reform walk. It likes one way bets: markets when they are rising, not when they are falling. And not just the futures markets have been told to get their minds right. Chinese authorities-and by authorities, I mean security services-have told fund managers not to sell, only buy. A market with Chinese characteristics, apparently: all buyers and no sellers. Kind of zen actually, in the spirit of “what is the sound of one hand clapping?”
This urge to exercise ham-fisted control is exactly the kind of thing that will impede China’s development going forward. It will undermine the ability of capital markets to do their jobs of incentivizing the accumulation of capital and directing it to the highest value uses.
China’s predilection for control has manifested itself in futures markets in other ways. You might recall some months ago that I wrote about China’s threats against Singapore and ICE if the American exchange offered lookalike contracts on ZCE cotton and sugar at its new Singapore affiliate. Yesterday ICE announced the contracts it will launch in Singapore, and cotton and sugar lookalikes were conspicuous by their absence.
No competition for us, thank you. We’re Chinese.
This protectionism may help ensure the success of China’s new futures market initiative: an oil futures contract. Protectionism and pricing in yuan and constraints on the ability of mainland firms to trade overseas make it likely that the contract will succeed. The Chinese are overoptimistic, however, if they believe this contract will supplant WTI and/or Brent. LME and COMEX copper, and ICE cotton and sugar, to give some examples, have thrived even as Chinese markets in these commodities grew. Moreover, myriad restrictions on the ability of foreigners to trade in China and the currency issue will make the Shanghai contract impractical as a hedging and speculative vehicle for non-Chinese firms and funds: the main non-Chinese trading will likely be arbitrage plays between Shanghai, CME/NYMEX and ICE, which will ironically serve to boost to the US exchanges’ volumes.
And the crushing of the CSI300 and CSI500 contracts will impede development of a robust oil futures market. The brutal killing of these contracts will make market participants think twice about entering positions in a new oil futures contract, especially long dated ones (which are an important part of the CME/NYMEX and ICE markets). Who wants to get into a position in a market that may be all but shut down when the market sends the wrong message? This could be the ultimate roach motel: traders can check in, but they can’t check out. Or the Chinese equivalent of Hotel California: traders can check in, but they can never leave. So traders will be reluctant to check in in the first place. Ironically, moreover, this will encourage the in-and-out day trading that the Chinese authorities say that they condemn: you can’t get stuck in a position if you don’t hold a position.
In other words, China has a choice. I can choose to allow markets to operate in fair economic weather or foul, and thereby encourage the growth of robust contracts in oil or equities. Or it can choose to squash markets during economic storms, and impede their development even in good times.
I do not see how, given the absence of the rule of law and the just-demonstrated willingness to intervene ruthlessly, that China can credibly commit to a policy of non-intervention going forward. And because of this, it will stunt the development of its financial markets, and its economic growth. Unfettered power and control have a price.