In days not too long ago, there was the saying that when the US markets sneezed, Europe caught a cold. Now it seems the tables have been turned, but the analogy with China goes only so far, as the US economy seems to be in the early stages of pneumonia. No less a person than the previous Federal Reserve Chairman Alan Greenspan is now openly saying that there could be a recession looming in the US. How Greenspan has changed in his old days since retiring from the Federal Reserve, as in a bygone era one could hardly get a straight word from this man who had moved markets.
Back to China and the recent events which saw the Shanghai stock market shed some 9 percent of its value on “Black Tuesday”, and with world markets “correcting” their bull market rallies of the past year. The Chinese markets fell after it became clear that, following weeks of warning, Chinese officials intended to take administrative action to cool off an overheated stock market, by curbing on illegal traders and introduction of taxes on trading gains. By all indications, Chinese officials seems to have quietly intervened to prop up the domestic share market when the fall came, as Beijing is clear that it wants stability, not volatility in its market.
The Chinese government is still hoping for market gains of some 20 percent-30 percent in 2007 after last years’ 130 percent boom. This puts it into comparison with the miserable returns experienced in the Saudi market and even other key world markets.
The Chinese markets have been opened up to foreign investors under the so-called Qualified Foreign Institutional Investors (QFII) program, and these hold around $10 billion of roughly the $400 billion in tradable domestic shares. The Chinese government will be closely watching to see whether the QFII’s had an outsized influence on the volatility seen in the past week’s trading. There has been some debate within Saudi Arabia, on whether the Saudi stock market could benefit from international trading and linking, and the Chinese experience will be interesting to watch.
While China’s “Black Tuesday” falls had some global ramifications, it has, in the final analysis, very limited domestic Chinese impact. Stock ownership is not yet widespread among the general population — with roughly 80 million registered brokerage accounts in China, or 6 percent of Chinese citizens exposed to the stock market. In Saudi Arabia it would seem that every other citizen has dealt in the local market, and hence the sharp collapse during 2006 affected more people in the domestic economy than China. Even in China, the actual percentage of brokerage ownership is likely lower, as illicit stock funds have become rampant, with market manipulators sometimes owning hundreds of individual brokerage accounts. Hence the Chinese governments move on these dealers.
In China, equity ownership among the urban middle classes has been growing strongly, but bank deposits and real estate holdings seem to be the more favored assets to hold, and Chinese officials have been at pains to avoid a rise in real-estate leveraging for stock purchasing, which is one reason why authorities felt the need to be pre-emptive to limit stock market gains to prevent such potentially destabilizing speculative behavior arising in China.
The contrast with what happened in Saudi Arabia’s bubble and burst in share prices could not be more striking.
China however, is an investment and export-led economy, not one primarily reliant on consumption. So any sharp equity market declines, while painful to a growing shareholding class, would likely have only a minor “wealth effect” consumption impact on the economy. This is in direct contrast with the US market, where a correction in the equity market could have a considerable ripple “wealth effect” on consumption, and hence the fears of a possible recession in the US.
Secondly, there are around 1,300 companies listed on China’s domestic stock markets and these are a puny number compared with the overall companies operating in the economy.
Of these, some 70 percent are large state-owned enterprises and even if their share prices fell, these enterprises receive their funding from state subsidies, not from equity issues.
Thirdly, Chinese corporations still rely mainly on bank loans — again from State banks — not the capital markets for their funding needs.
The final bottom line for China’s equity markets is that even if share prices were to fall further, and this is something the Chinese authorities will strive to prevent by intervention, such falls would have little spillover effects into the rest of the Chinese economy, which is still expected to grow at “only” 10 percent levels in 2007.
And what of the rest of the world’s reaction?
By right, proposed regulations in China ought not to have given such a big jolt to global markets, as despite China’s impressive growth over the past few years, the Shanghai exchange remains tiny in comparison to other Western equity markets. The implication is that the Chinese fall seems to have been a pretext to burst the bubble of some overheated equity markets particularly that of the US, coupled with debates and doubts on how the US is managing its ballooning international and domestic debt.
It could just be that the Chinese fall and world reaction was what was needed — in essence, a slowdown in the global equity markets to rebalance the world’s economy, and shake up the US addiction to external borrowing. If the US can achieve this internal rebalancing act, then it might just avoid the prospect of contemplating a change in the balance of power between world markets, whereby New York might find itself hostage to foreign market performances. Watch this space as they say …
(The writer is a visiting associate professor, Finance and Economics at King Fahd University of Petroleum and Minerals).