Economists hate price and wages controls. They distort the natural forces of markets and usually result in pent-up demand and/or supply which will be unleashed at a later stage as well as a range of unexpected distortions. Investors, too, should hate them.
Last week’s news from China was that the government is starting to lean on food producers and vendors to keep prices down. More importantly, the State Council said that in times of need it would intervene in setting the price of food and raw materials. This was a response to published figures showing that the price of most food staples had increased by at least 60 per cent in the past year.
But the government not only adopted, or warned it would adopt, a sledgehammer approach. It also warned about another increase in interest rates – September’s 25bps rise was the first for three years – and moved to boost food supplies through some new subsidies in rural areas.
From an investor’s perspective, it is difficult to find a reasonable body of evidence regarding the impact of price controls on share markets, except in China. China has had more of a history in this regard than any western country in the past 50-or-so years.
According to HSBC in a client newsletter this week, price controls were last used in 2008 nationwide and in selective regions the year before. The 2008 controls coincided with peaking oil prices and an epidemic, called blue-ear pig disease, which hit pig production. The controls were taken off as the global financial crisis took hold and inflation fears waned.
Steven Sun, HSBC’s China equity strategist, says: “The 2008 experience suggests that the equity market doesn’t like price controls.”
Crunching the data, Sun discovered that when caps were introduced three years ago, the MSCI China index dropped 14 per cent in the following three months. Should price controls be declared once again, he forecasts the Shanghai A-share market dropping to 2,800 (from 3,001.80 Monday).
While this would not be great news for investors, it is not particularly worrying in itself. More important is what it signals about the Chinese government’s concerns over keeping its great populous happy. Food prices, in a country which still has 16 per cent of its population below the poverty level, as defined by the United Nations ($1.25 a day adjusted for purchasing power parity), are very important. So, blunt instruments will be used if necessary and hang the consequences.
The signal is that, long-term, the threat to Chinese growth is not so much that it may be a bubble but more whether it can cope with the rising expectations of its population. This is the judgement call that western investors need to make.
The HSBC newsletter says: “In his new memoir, Decision Points, George W Bush recalls asking Hu Jintao what kept him awake at night. The Chinese president replied: ‘Finding 25 million new jobs per year’.
“That answer reveals the economic tightrope China’s leadership must traverse. Its primary objective is to ensure social stability. One major facet of this is creating enough jobs to prevent massive unemployment. But another is managing inflation, and most particularly the price of food.
“So, if Hu had given Bush a less pithy response, he’d probably have added that thinking about how best to keep cooking oil, pork and vegetables affordable also gave him the occasional sleepless night.”