Beijing’s problem in dealing with such characteristics, however, is that the “normal” tools to rein in an overheated stock market would actually cause more problems than they would solve.
Perhaps the most reliable way to cool off any portion of an economy — stock markets included — is to jack up interest rates. Reducing access to capital slows investments of all types and certainly makes dubious practices that are common in China — like taking out a second mortgage or other loan to purchase shares — less attractive. It also would make traditional savings accounts far more appealing.
But such an obvious option is a nonstarter in China. The defining characteristic of the Chinese economic system has traditionally been cheap capital made possible by interest rates held below the rate of inflation. This cheap capital in turn is used for two key objectives: first, to prop up any and all state bank-funded projects that help ensure maximum employment and thus contain social pressures; second, to fund Chinese government purchases of U.S. Treasury bills, which helps contain the pace of the yuan’s appreciation. Though benchmark interest rates have been increased four times in the last year alone, such increases have been minor and aimed exclusively at dampening lending, not at changing savings patterns.
But the cheap capital ultimately has to come from somewhere — in this case, the famed Asian savings rate. Some of that cash has obviously leaked out of urban dwellers into the stock market in a manner that is flirting with disaster, but should the core cash that China’s millions of savers funnel to the state via their deposits actually pay meaningful interest the result would be disastrous. Should China lose the ability to capture that cash, interest rates would have to climb to maintain the size of this deposit pool. The subsequent shortage of cash would make it more expensive for banks to issue loans to loss-making state-owned enterprises, potentially causing some state-subsidized sectors to screech to a halt if not collapse outright.
Which means the only real way to slow the surge of liquidity into the stock markets is to offer more options. Of course the question then becomes: What options? Products like the U.S. 401k require a far deeper, more sophisticated and better regulated system. There are always property markets, but they already are suffering from a bubble more dangerous than the stock markets.
China does not yet have a mature corporate bond market, and its derivatives market and commodity markets are so new and underdeveloped that a large surge of capital into them now would simply institutionalize all of the stock market’s shortcomings into them as well. This leaves Chinese investors with few options — and Beijing with a stock market that simply cannot slow down without collapsing altogether.
My son leaves for China on the 14th of this month. He is going to a small city (small by chinese standards) called Panjing, as I recall, in Manchuria, about five hours north of Beijing. He will be teaching English to Chinese kids for the summer before going to Qinghua university in the fall. I will post relevent portions of his letters here if the blog is interested. Kendall, what do you think?
Larry
Sounds fascinating, do email it to me.