As expected, yesterday saw pretty awful performances on the local stock exchanges, with the SSE Composite down 5.2%, followed by a 0.7% loss today.  Given what is happening around the world this is pretty standard stuff, but it does put an effective end to the latest attempt by the government to rally markets.  Unless we get some more interference from the government, or a big rally abroad, we are going to drift back down to test last month’s lows. 

Yesterday in fact there was an attempt to “signal” the market into positive territory.  The PBoC announced that they would once again permit companies to issue medium term bonds, and that the proceeds could be used to repurchase shares, but the market wasn’t impressed.  Good.  I wonder if decapitalizing companies and increasing leverage in the system is the best way to deal with upcoming volatility.  I hope companies are fairly sparing in their use of this new privilege.

Tom Holland has an interesting new piece in the South China Morning Post arguing that Beijing has much less room for fiscal expansion than is widely assumed.  I think this idea that fiscal expansion can get us out of the current mess needs to be much more seriously debated, and I am glad he is doing so.  

His argument has two parts.  First, he says, the balance sheet isn’t as clean as we might think. Problems in the banking system can have a very large impact on the government budget.

As the economy slows, the proportion of non-performing loans in the state-controlled banking sector is certain to rise, bumping up the government's contingent liabilities.  That's important, because although the official ratio of bad loans at the end of June was just 5.6 per cent of banks' total loan books, the absolute amount was more than 17 times the government's budget surplus for the whole of last year. Clearly it wouldn't take much of an increase to knock a big hole in banks' capital and, ultimately, in the government's own finances.

I think he is right and would actually go a little further.  There is already more debt out there than we think.  Today’s Bloomberg quotes a more optimistic Morgan Stanley analyst on the subject:

China can “afford to run multiyear fiscal deficits without running into debt sustainability problems,” because it has public debt of only 30 percent of gross domestic product, Wang said.