林中斌 部落格 / Blog Chong-Pin Lin

China Embraces the Markets

The Economist, JULY 11, 2015

http://www.economist.com/news/leaders/21657395-panicked-response-tumbling-stocks-casts-doubt-pace-reform-china-embraces accessed July 20, 2015

倫敦經濟學人說在中國股災表象之下，中國經濟依然實在，銀行穩定。這是北京大力救股市之前所說的。

林中斌 2015.7.20

FOR nearly two years, hopes of economic reform in China have rested on the faintest of rhetorical shifts. At a conclave in late 2013 the Communist Party declared that it would let market forces play a “decisive role” in allocating resources; previously, their influence had been just “basic”. A slender reed perhaps, but it supported a great expectation: that the state would ease its grip on business, trade and finance.

These hopes have been dealt a blow this week by China’s stockmarket crash. By the end of July 7th trading in over 90% of the 2,774 shares listed on Chinese exchanges was suspended or halted. Shares have fallen by a third in less than a month, wiping out some $3.5 trillion in wealth, more than the total value of India’s stockmarket. It is not the plunge in share prices, however, nor the implications for the Chinese economy that are worrying, so much as the government’s frenzied attempts to bring the sell-off to a stop.

The market mayhem is the first grave economic blemish on Xi Jinping and Li Keqiang, China’s leaders. Officials’ botched attempts to repair the damage have only made a bad situation worse. The danger now is that the party draws the wrong conclusions—leaving China more vulnerable to instability.

Red flag

The first mistake—often made by China pessimists—is to think that the market crash presages an economic collapse. That is most unlikely. True, the stockmarket is down by a third in a few weeks, but it has fallen back only to March levels; it is still up by 75% in a year.

Lost in the drama is the fact that the stockmarket still plays a small role in China. The free-float value of Chinese markets—the amount available for trading—is just about a third of GDP, compared with more than 100% in developed economies. Less than 15% of household financial assets are invested in the stockmarket, which is why soaring shares did little to boost consumption and their crash should do little to hurt it. Many stocks were bought with debt, and the unwinding of these loans helps explain why the government has been unable to stop the rout. But such financing is not a systemic risk; the loans are about 1.5% of total assets in the banking system. The economy is solid. Growth, though slowing, has stabilised. The property market, long becalmed, is picking up. Money-market rates are low and steady, suggesting banks are stable.

To be fair, Chinese officials understand this. The trouble is that they are less willing to accept the two fundamental causes of instability: the structure of markets and China’s brittle politics. Take each in turn.

From mid-2014 until early June, ChiNext, a market for start-ups, more than tripled. China’s mania derived partly from the way the market functioned. Regulators act as gatekeepers over initial public offerings, in effect deciding which firms list, when and at what price. Because the government was initially slow to approve new IPOs, those firms already lucky enough to have ChiNext listings became financing vehicles. Investors pumped their shares higher, knowing that the capital could buy firms waiting in the long queue to list. Hence the wooden-flooring company that remade itself as an online-gaming developer and the fireworks-maker that became a peer-to-peer lender, among dozens of similar mutations. Before long, the ChiNext price-to-earnings ratio had reached 147, putting it in the same league as NASDAQ during the dotcom era.

China’s repressed financial system helped inflate the bubble by pumping money into the stockmarket. Banks pay interest rates well below the level that would be expected without regulatory caps, and China has yet to develop alternatives for savers looking to park their cash elsewhere. The hunt for good returns has over the past decade sparked investment frenzies in property, stamps, mung beans, garlic and tea. Steps to give investors better access to foreign markets and to free up bank rates all aim in the right direction but progress has been halting. Equities were as ripe for a bubble in 2015 as they were in 2007, the last time China experienced a stock frenzy.

If economic stability is not in peril, the best explanation for the interventions is politics. When the stockmarket was soaring, the press cheered the bull run as an endorsement of the economic reforms of the Xi-Li team. Now that it is falling, regulators want to shore up the leadership’s reputation.

It is not just the motive that is dodgy; the nature of the intervention is also unwise. Cutting interest rates as support for the economy when inflation is so low is fair enough. But regulators capped short-selling; pension funds pledged to buy more stocks; the government suspended initial public offerings; and brokers created a fund to buy shares, backed by central-bank cash (see article).

Just as the Communist Party distrusts market forces, so it misunderstands them. Botched attempts to save stocks suggest it is losing control, while a successful rescue would have made buying shares a one-way bet—inflating the bubble still further. One of the persistent illusions about China’s governance is that, whatever its other shortcomings, eminently capable technocrats are in control. Their haplessness in the face of the market turmoil points to a more disconcerting reality.

China is not the first country to prop up a falling stockmarket. Governments and central banks in America, Europe and Japan have form in buying shares after crashes and cutting interest rates to cheer up bloodied investors. What makes China stand out is that it panicked when a correction of clearly overvalued shares had been expected. Rather than calming investors, its barrage of measures screamed of desperation.

Go faster

The journey from command to market economy is a long and dangerous one. China has managed it well. But, in financial markets, it still has a long way to go. After the bedlam of this week, it must realise that being partially liberalised presents investors with perverse incentives and policymakers with extraordinary demands. China must not go slow or turn back. That would be the most dangerous path of all. Instead, the real lesson from this week is that it must let the markets decide.