The notion of motion

10 December 2014 By John Foley

China’s gyrating stock markets are a reminder that movement matters. Volatility is increasing in the People’s Republic, and fighting it is a losing battle.

Prices of stocks have tumbled in recent days, but that alone isn’t frightening. Equity markets are just back to where they were a week ago; yields on triple-A and double-A five-year bonds are back to October’s level. But their tendency to jump around has increased. In the past week, stock-price volatility has jumped to levels last seen in 2009.

China has encouraged some kinds of swings. The yuan has been allowed to fluctuate with the aim of driving away speculators. Its implied volatility, based on one-month option prices, is at a three-year high. Other oscillations – like changes in house prices or banks’ tendency to massage their deposit balances up and down – have been suppressed. For the ruling Communist Party, political volatility is still to be avoided at all costs.

Market gyrations can help some speculators make money. They are less good for companies. Lurching yields forced China Development Bank to cancel a bond issue on Dec. 9. And even though Chinese corporations barely use equity markets to raise capital, it’s logical to think that one day they will. Foreign investors are becoming more wary about long-term investment, because they fear rules and regulations have become unpredictable, and less consistently enforced.

The fallacy is to think that volatility can be controlled before it influences behaviour. The yuan is a good example. Over the past week it has weakened sharply, even though the People’s Bank of China has been setting its starting value stronger each day. A record trade surplus suggests the currency should be strengthening. Investors have other ideas.

Too much volatility is catching. Even though most Chinese citizens don’t own shares, continued wild swings in stock markets could undermine the notion that prices of other assets too are within the purview of the authorities. If the central bank appears to have lost control of the currency, capital may flee. Then the good kind of volatility will be hard to distinguish from the bad.


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