September 1, 2015 / 4:06 AM / 2 years ago

COLUMN-Investment risks grow with China strong-arm tactics: James Saft

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

Sept 1 (Reuters) - The arrests and "confessions" will continue, it seems, until Chinese stock market morale improves.

China's efforts, not just to manipulate its stock market higher, but to squelch information and intimidate those it sees as threats to its purpose should also scare global investors.

The spectacle of Wang Xiaolu, reporter at a Chinese business publication, enacting Monday what authorities called a confession of spreading "panic and disorder" in the stock market through his reporting should scare investors.

The announcement Sunday by China's Ministry of Public Security that 197 people had been punished for spreading rumors about stocks and other issues should scare investors.

That the head of hedge fund manager Man Group Plc's China unit has been taken into custody, as reported by Bloomberg on Monday, should scare global investors.

This is a practical, not a principled, argument. Some might say that it is wrong to support with your money a regime with a lack of respect for human rights and the rule of law. Wrong perhaps, but as a stock investor foolish definitely.

All of these actions by China are confessions not of strength but of vulnerability, the kind of vulnerability which requires a much higher risk premium than Chinese securities are currently offering. The exact nature and mechanism of China's vulnerability to a falling or volatile market we can't know from outside, only that it is big enough to spark what are likely self-defeating actions.

All of this puts me in mind of comments by risk analyst Nassim Nicholas Taleb on Monday that the best way to get to know people is by discovering what they lie about.

"Corollary: To figure out with some precision what will bankrupt a firm, find out what they tend to lie about (or exaggerate) the most," Taleb said via Twitter.

The same, roughly, holds true, I'd venture, about countries and what they suppress. To know what threatens them, and by extension those who commit their capital to them, examine what they suppress.

Even putting aside conclusions about the accuracy of Xiaolu's reporting, or the good conduct of those "assisting" authorities with their enquiries, we can note that journalists and market participants weren't being arrested and paraded bleary-eyed before cameras when the Chinese stock market was staging its vertiginous rise.

SELF-DEFEATING

Only when it fell, rapidly, did Chinese authorities begin their campaign, and the common denominator appears to be that those who provide information suggesting that it may fall will be taken firmly in hand.

There is an old argument in academic circles about whether foreign direct investors prefer to put their money to work in repressive regimes. The argument, as far as it goes, is that those building a business or factory in a repressive place retain control over the workings of the business but get benefits not offered by democratic countries; preferential terms or the ability to "get things done" with ease.

For portfolio investors, people who might buy Chinese stocks, the equation is a lot simpler. You will be less well protected as an investor in such a place, and have less good information. The only way to counterbalance that is to get those securities at a better, cheaper price, one which offers more risk insurance against the rights, information and protections you can expect not to have.

China's actions, therefore, are self defeating. This is somewhat similar to the suppression of short-selling by any number of countries during times of financial turbulence.

Investors, those who have a choice, should reasonably ask more in prospective return from China stocks, implying lower not higher prices.

This is not to say that China isn't capable of browbeating and arm-twisting and public money spending its way to a higher stock market. China asked brokerages to increase their support of a market rescue fund by 100 billion yuan last week, according to reports, a move perhaps tied to a desire for a rally, or at least stability, ahead of Thursday's parade commemorating victory over Japan.

Thursday, and the parade, will pass, and investors will have learned little about history but know less, and less exactly, about the state of China's economy, companies and markets.

They do know that a huge country is scared so badly of something that they will not, cannot, allow things to be said that cause stocks to fall.

Remember too: this is all of a different degree and nature from market support measures done in the U.S. and Europe, as regrettable as some of those may be too.

China is telling not just its reporters and market players to be afraid, it is sending a message of heightened risk to the rest of the world's investors. (At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft) (Editing by James Dalgleish)

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