The Economist - UK (2022-05-07)

The Economist May 7th 2022 Finance&economics 67

rally”  of  2014;  stress  in  the  repo  market  (a
key money market where Treasuries can be
swapped for cash) in September 2019; and
the covid­19 shock of March 2020, in which
the  Treasury  market  in  effectceased  to
function for periods of time—have created
serious doubts about how robust the Trea­
sury market is. 
Each of the episodes had slightly differ­
ent causes. Regardless of the robustness of
the  Treasury  market,  there  was  little  that
would have stopped the extreme nature of
the covid­19 shock from rocking it. The re­
po crisis was in part the result of some per­
verse incentives caused by post­crisis reg­
ulation  that  deterred  banks  from  holding
Treasuries. But both were exacerbated by a
deeper issue, says Randal Quarles, a former
vice­chair  for  supervision  at  the  Fed,
which  is  that  the  Treasury  market  “has
grown out of its waist size”. 
A combination of financial­crisis stim­
ulus, fiscal deficits under President Trump
and pandemic­era splurge have caused the
Treasury  market  to  grow  nearly  five­fold
since 2007. At the same time fresh regula­
tion imposed on investment banks, which
are the main conduits in Treasury markets,
such  as  the  introduction  of  the  supple­
mental­leverage ratio, which measures the
total  size  of  bank  assets  relative  to  the
amount of capital they hold, has restricted
their  ability  to  facilitate  Treasury­market
activity.  The  rule  is  not  very  friendly  to
low­risk  activities,  such  as  holding  Trea­
suries.  A  report  released  last  year  by  the
Group of Thirty, an economics advisory bo­
dy,  warned  that  “the  aggregate  amount  of
capital  allocated  to  market­making  by
bank­affiliated  dealers  has  not  kept  pace”
with its lightning growth. 
To combat issues that have cropped up
in  the  past  the  Fed  has  taken  measures  to
increase  liquidity,  such  as  opening  up  a
“standing  facility”  for  selected  intermedi­
aries  to  swap  Treasuries  for  cash.  But  few
think  that  this  is  a  panacea  for  dysfunc­
tion.  Mr  Duffie  favours  replacing  the  cur­
rent market structure, which relies on bro­
ker­dealers,  with  a  central­clearing  sys­
tem. This would make it easier for market
participants  to  interact  directly—for  one
mutual fund, say, to sell to another without
relying on a bank to intermediate the tran­
saction. But the fix would be no match for
“the scale of the problem”, says Mr Quarles.
A more urgent task, he argues, is to loosen
the regulatory shackles hampering invest­
ment  banks  from  supporting  the  market.
That  is  unlikely  to  happen  soon:  there  is
little  appetite  in  Washington  for  weaken­
ing bank regulation. 
In the absence of an obvious fix, the un­
knowable fallout from the Fed’s pull­out is
adding to the uncertainty created by rising
rates, stagflation and geopolitical ructions.
Liquidity in the Treasury market is already
thinning: the “yield error” captured by the

BloombergTreasuryliquidityindex,which

measuresthedifferencebetweentheyield

a Treasuryistradedatanda measureoffair

value,is12%higherthanitwasinJanuary.

It has more than doubled since August

2021. Thegrowingpossibilityofrenewed

dysfunction could deter investors from

dealingfurther,makingityetlikelierthat

themarketseizesup.Theonce­placidlife

ofTreasurybillsandbondscouldgetmore

chaoticfora while.n

T-bills, bills, bills

United States, Treasury-security holdings, $trn

*Excludingintragovernmental debt

25

20

15

10

5

0

191715132011 22

Total outstanding*

Held by the

Federal Reserve

Source: St Louis Federal Reserve

Chinesestocks

Flee market

O

n may 3rdinvestors in Chinese stocks

woke up to the news that Jack Ma, the

co­founder  of  e­commerce  giant  Alibaba,

had  been  arrested  on  national­security

charges. Or so many of them thought. State

media  were  reporting  that  a  tech  worker

with the surname Ma had been detained in

the  city  of  Hangzhou.  The  description

seemed  to  fit  that  of  the  billionaire  tech

magnate,  whose  companies  are  based  in

Hangzhou and have been subject to a regu­

latory  onslaught  over  the  past  year.  The

speculation,  it  rapidly  turned  out,  was

wrong  (Ma  is  a  common  family  name  in

China).  But  not  before  Alibaba  shares

dipped  9%,  temporarily  wiping  out  more

than $25bn in the firm’s market value. 

The incident shows how fragile market

sentiment  has  become  in  China.  Beijing’s

unpredictable,  often­shocking  policy

swerves in recent years have made it all the

more  conceivable  that  the  country’s  most

prominent  entrepreneur  could  suddenly

be  accused  of  attempting  to  “split  the

country and subvert the state”. President Xi

Jinping’s  increasingly  ideological  cam­

paign to rid China of the Omicron variant

ofcovid­19isthreateningtothrottleeco­

nomicgrowththisyear.Hisunwavering

supportforRussia,evenasVladimirPutin

commitswarcrimesinUkraine,hasfur­

therfuelledtheperceptionthatthecoun­

try’sleaders,onceknownfortheirpragma­

tism,arefaltering.

Theshifthasbeenpunctuatedbygloo­

my comments from prominent experts

whountilveryrecentlyremainedupbeat

onChina.StephenRoach,theformerAsia

chairmanofMorganStanley,a bank,has

longdefendedChinesepolicy.Butina re­

centarticleinProjectSyndicate, anonline

publication,hesaid“theChinacushion”,

theeconomicmightthathelpedpowerthe

worldthroughtheglobalfinancialcrisisin

2008, had “deflated”. Shan Weijian, the

chiefexecutiveofpag, a HongKong­based

private­equityfirm,recentlytoldinvestors

theChineseeconomy“atthismomentisin

theworstshapeinthepast 30 years”,theFi-

nancialTimesreported.

Some useharsher language—andare

gettingpunishedforit.JoergWuttke,the

head oftheEuropeanchamber ofcom­

merceinChina,lastweeksuggestedinan

interviewwitha SwisswebsitethatChina’s

zero­covidstrategyhasputmanydecision­

makersin“self­destructionmode”.Hong

Hao,anoutspokenanalystatBankofCom­

munications,a statelender,recentlyhada

Chinesesocialmediaaccountfrozenafter

hepublished anegativeoutlook onthe

economy.Hehasnowleftthebank.

Muchofthedarkeningsentimenthas

been focusedon MrXi’s covid strategy.

ClosingdownShanghai,China’sbusiness

andfinancialhub,seemedunimaginable

onlya fewmonthsago.Butthecityof25m

has undergone a strict lockdown since

April1st.Flare­upsofcovidinBeijingand

othercitieshavepromptedtargetedlock­

downs.Aregimeoftestingforthevirusis

quicklybecomingpartofeverydaylife.

Thecostsofcontrollingthespreadof

Omicronarebecomingapparent.Factory

activityhassuffereddearlyandstrainson

shippingandlogisticsareripplingthrough

globalsupplychains.Thecentralgovern­

S HANGHAI

China’s erratic policies are

terrifying investors

Dimming sums

Net non-resident portfolio equity

flows into China*, $bn

Source: Institute of

International Finance *Four-week moving average

4

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