Headline of the Day: Death of the World’s Biggest Stock Market Index Futures Market By Capital Controls

My previous admonition on the likely repercussions of the Chinese government’s massive intrusion on her stock market:

Since markets are about exchanges or buying and selling, if one of the main function is banned, or severely regulated or impaired through the arbitrary interferences by politicians, who determine and impose on the price levels, then markets do not exist at all. Liquidity will practically shrink, if not evaporate. People’s resources will get stuck into assets that have no exit mechanism. So Xi Jinping Put will mutate into a Frankenstein market.

Capital controls not only inhibits movements or confiscates people’s properties, they reduce the economy’s access to capital.

Yet if the ‘war against sellers’ fails, which will be manifested through sustained downfall of Chinese stocks, then the Chinese government may likely declare a stock market holiday.

Well the segment of evaporating liquidity has now hugged the headlines.

From Bloomberg: (bold mine)

Add the world’s biggest stock-index futures market to the list of casualties from China’s interventionist campaign to stop a $5 trillion equity rout.

Volumes in the country’s CSI 300 Index and CSI 500 Index futures sank to record lows on Tuesday after falling 99 percent from their June highs. Ranked by the World Federation of Exchanges as the most active market for index futures as recently as July, liquidity in China has dried up as authorities raised margin requirements, tightened position limits and started a police probe into bearish wagers.

While trading in Chinese equities has also slumped amid curbs on short sales and an investigation into computer-driven orders, the tumble in futures volumes may cause even greater damage because of their central role in the investment strategies of domestic hedge funds and other institutional money managers. A failure to revive the market would undercut the government’s own efforts to attract professional investors to local stock exchanges, where individuals still account for more than 80 percent of trades.

“It is further evidence that the Chinese authorities are not yet ready to commit to freely trading markets,” said Tony Hann, a London-based money manager at Blackfriars Asset Management, which oversees about $350 million. “Fully functioning developed financial markets in China will take many years.”

Popular Tool

Chinese policy makers, intent on ending a selloff that has eroded confidence in their management of the economy, are targeting the futures market because selling the contracts is one of the easiest ways for investors to make large wagers against stocks. It’s also a favored product for short-term speculators because the exchange allows participants to buy and sell the same contract in a single day. In the cash equities market, there’s a ban on same-day trading.

Yet futures are also a popular tool among sophisticated investors with longer-term horizons. For hedge funds, they provide an easy way to adjust exposure to market swings. And large institutions use them to make cost-effective asset-allocation changes. As an example, selling index futures might be cheaper than unloading a large block of shares -- an order that could put downward pressure on prices.

A sustained slump in liquidity may spur some institutional investors to “give up hedging in futures, unwind futures positions and reduce their stock positions,” said Dai Shenshen, a trader at SWS Futures Co. in Shanghai.

China, which has been investigating evidence of “malicious” short selling since July, stepped up curbs on the futures markets on Monday. The China Financial Futures Exchange now labels a position of more than 10 contracts on a single index future as “abnormal trading.” While the bourse said the restriction won’t apply to futures used for hedging purposes, it didn’t detail how it will identify such trades. Before last month, investors could have as many as 600 contracts.

The bourse also raised fees for settling positions opened on the same day to 0.23 percent from 0.0115 percent. Margin requirements on stock-index futures contracts were lifted to 40 percent from 30 percent. For those with hedging demand, the levels climbed to 20 percent from 10 percent. Exchange officials didn’t respond to e-mailed questions from Bloomberg News on Tuesday.

Futures trading on the CSI 300 Index, a gauge of the nation’s biggest companies, shrank to just 34,085 contracts on Tuesday. That’s down from 3.2 million at the end of June and compares with the 30-day average of 1.7 million. For the CSI 500 Index of small-cap shares, futures volumes have dropped to 13,167 from about 144,000 a month ago.

A slomo death of the stock market it has been for China!

So the way for the Chinese government to the “stabilize” the market has been to disable sellers. 

Sellers have been castrated to the extent that people can only sell based on the prices that is considered politically allowable.

Yet all these massive interventions, i.e. capital controls, restrictions, intimidation, harassment, which includes the arrests of politically incorrect media personalities and industry participants, humongous credit financed mandated frantic bidding up by state owned enterprises haven’t been as smooth sailing as desired for by the authorities. 

China’s major equity bellwether the Shanghai Composite remains under severe pressure in spite of the raft of financial repression measures imposed. The SCOMP trades at the December 2014 to February 2015 levels as shown by the stockcharts.com

So throw “everything but the Kitchen sink” to manage the headlines!

Like the Philippine counterparts, the Chinese government has been obsessed with showbiz everything—economy, domestic politics, international relations or geopolitics, financial markets and more…

Touted reforms? Well the only reform that has become so evident has been of the deepening centralization or the reversal of market liberalizations to an anachronistic command and control economy instituted through political, economic, and financial market repression.

Yet while the Chinese government may succeed in pushing the stock markets up, the impairment of the foundations of stock markets, as already envisaged by liquidity drought, ensures that this would not be lasting. 

Moreover, such would have grave adverse repercussions down the road. 

Since everything is connected, ramifications will not be straightforward but will likely be manifested through various economic-financial pores: debt levels, interest rates, CPI, capital flows, currency or the property markets among many other possible rivulets.

The Chinese version of the tainted King Canute has yet to learn humility from their ‘fatal conceit’. 

They have yet to understand that as the great Ludwig Mises warned (Human Action,  p 552)…

The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system.

So if all fails what’s next? The closure or a public holiday of the stock market?