Beijing's Mighty Hand

Is the China party screeching to a halt?

It may well be one of the biggest financial news stories of the year - how the Chinese government decided enough was enough, and clamped down on the investing frenzy to curb overheating in the economy.

In a move described as "guidance aimed at supporting the macro-control measures being implemented," local and Chinese subsidiaries of foreign banks are urged to ensure that loans at the end of the year don't exceed the total outstanding on Oct 31. With this edict, banks can cutting loans and credit lines to individuals and businesses.

And the effects are already felt as both the Shanghai and Hong Kong bourses fell today, spooked by concerns of credit drying up and sentiments shrivelling. It will not be surprising if the broader regional market take a hit too.

It is somewhat ironic that just five days ago, the Washington Post was raving about the "explosive growth" in China. Its article - "U.S. Buyout Kings Bet on China: Private Equity Attracted By Explosive Growth" had investment gurus gushing about the China story.

One wonders whether they will be caught with their foot in their mouths when the party of runaway stock prices dramatically stops due to this sweeping move from Beijing.

The Wall Street Journal wrote:

"Even a temporary lending freeze, however, could cast a chill on important segments of the Chinese economy, including the stock market, whose steep run-up over the past year has given rise to fears of a speculative bubble. Though off their highs, Chinese share prices have nearly doubled since late 2006."

The signs were already there that Beijing would take action however.

Officials have repeatedly said that China's top priority remains preventing economic overheating, with the focus on curbing investment growth and the supply of excess credit. The inflation numbers that hit an 11-year high last month of 6.5 percent probably forced Beijing's hand to rein in an economy that showed few signs of slowing.

Mainland authorities are also not wont to take a strong hand. Banks in Shenzhen were recently ordered to limit daily cash withdrawals in a bid to cut off sources of unauthorized investment in Hong Kong stocks.

Certainly, not everybody is enamoured by the China story.

Amid the bullish bubbliness, the Washington Post story quotes David Chao, co-founder and senior Asia partner for DCM Capital Management (He should know a thing or two. DCM was one of the first private-equity and venture firms to invest in China):

"Because China is growing double digits, suddenly it is viewed as a panacea. But I think you need to peel the onion. What's going on inside China is that many domestic Chinese companies that have recently gone public are getting crazy valuations. So no matter how you see it from the outside, it certainly looks like a bubble. You need to tread in China with a lot of caution."

And MarketWatch reported that a top-performing investment newsletter - Cabot China & Emerging Markets Report - has also called the China bluff:

"It's no use guessing what comes next. Your best move is to respect the China-Timer's new bearish signal by selling your losers and poorest performers, holding plenty of cash, and holding off most new buying until the bulls retake control."

Drastic action normally precedes equally dramatic consequences. It will be interesting to see what unfolds in the days ahead.