Stock Market Illustrates Chinese Central Planning Dilemma

April 24, 2015 Updated: April 24, 2016

Sometimes we should cut the Chinese central planners some slack. It’s hard to centrally plan an entire economy, especially the stock market. In essence you have to achieve at least two completely contradictory goals at the same time.  

Although officials will never admit this to be true, we can only explain the recent actions of the People’s Bank of China and the securities regulators this way.

One day, they do something encouraging rampant speculation (more liquidity from the central bank), then they do something to rein in speculation (encourage short selling, reduce margin buying).

A record 3.25 million new retail broker accounts were opened in the third week of April alone.

It seems the encouraging measures have the upper hand for now, as the stock market is now up 121 percent since its low at the beginning of 2014. After the regulators relaxed restrictions on how many trading accounts an individual could open on April. 10, a record 3.25 million new retail broker accounts were opened in the third week of April alone.

The central planners want to have their cake and eat it to. On the one hand, they want to stop a faltering economy and a crashing real estate market by pushing liquidity into the system, which is increasingly not working. They also want to keep people happy in a not ideal economic environment by letting them make money in stocks.

However, the central planners in Beijing also know that this speculation party completely devoid of economic fundamentals cannot go on forever, as we last saw in 2007.  If it crashes, people will be unhappy.

The Shanghai Composite is currently valued at 17.3 times its forward earnings, compared to a three-year average valuation of 9.7. The S&P 500 index trades at 17.7 times, but the U.S. economy is moving upward, not downward, like the Chinese.

Until that changes, Chinese central planners will have to keep walking the tight rope between too much and too little speculation.