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By George Wehrfritz
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By the time China's main stock exchange ended a four-day free fall last week, the paper wealth destruction was extraordinary. When share prices finally hit bottom, the financial-news service Bloomberg calculated, the combined losses on the Shanghai Stock Exchange exceeded $500 billion—roughly Taiwan's and Singapore's combined GDP last year. Yet most interesting was what did not happen next: a global stock sell-off. In fact, a 21 percent drop in the main stock exchange of the world's fourth largest economy made barely a ripple in Tokyo, Seoul, Hong Kong or Singapore (not to mention London or New York). The lesson: "The Chinese stock market is largely divorced from the rest of Asia," says Chua Hak Bin, an economist at Citigroup Global Markets in Singapore.
That's welcome news, if it indeed holds true. Many economists had started to argue, to the contrary, that China is emerging as a prime market mover. The world's fastest-growing major economy, the logic goes, China is now a key driver of global growth and, by extension, of global investor sentiment. That perspective was reinforced back on Feb. 27 when a 9 percent plunge in Shanghai triggered sharp falls in New York, London and Tokyo—suggesting a new and potentially volatile linkage between Asia's tempestuous dragon and the world's leading financial centers. So why, then, did global markets shrug off a much larger correction in Shanghai last week? "Markets are very efficient learning devices," says Tim Condon, chief economist for Asia at ING. "After the February episode, people studied China's stock markets, and the details were comforting."
For starters, analysts have come to realize that China's stock markets are still tangential to its real economy. Listed companies, the vast majority of which are controlled by the state, "only represent a very small percentage of companies that exist in China," says Arthur Kroeber, director of the consultancy Dragonomics Research in Beijing. Nor are they very widely held. Despite a rush of new retail investors into the market this year, average households now keep just 10 percent of their wealth in stocks, roughly a third of the average in the U.S. Even a full-blown market crash, Kroeber figures, would have scant impact on household wealth or spending. Citibank recently estimated that a 30 percent fall in Chinese stocks would slow GDP growth by 1.5 percent, from 11.1 percent today to 9.6 percent, which is still blisteringly fast.
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Another lesson: China's financial system remains locked behind a bamboo curtain. Its currency isn't convertible, strict capital controls prevent "hot money" from entering and exiting the stock market with the push of a button, and the vast majority of investors are Chinese nationals with no easy access to global stock exchanges, foreign mutual funds or offshore banks. In short, China's captive investors operate within a system closed to the kinds of foreign money flows that brought down Asian currencies and stock prices during the 1997-98 financial crisis.
Beijing also deserves some credit for telegraphing Shanghai's troubles. Beginning in April, senior officials began issuing public warnings of a "stock bubble." Chinese investors, who are entering the market by the thousands each day, at first ignored the admonitions; outsiders got the message, so there was no surprise factor. "People in a way saw this coming," says Henry Tang, Hong Kong's financial secretary. "Everyone was more psychologically prepared for something to happen [and for] macroeconomic measures to cool off some of the steam."
One disconcerting aspect of the fall was the invective it unleashed within China, particularly on the Internet. Much of it focused on Beijing's decision to triple the stamp duty on stock transactions, which did what it was supposed to do—slow the market—perhaps a bit more quickly than it was intended. On a Sina.com blog, however, one respondent claimed he "felt the blood and tearful eyes of tens of thousands of shareholders ... afraid of being robbed of their treasure," adding, "The robbers are the current government." Analysts have warned that a full-blown market collapse in China could unleash urban unrest. By late last week, Beijing was using China's state media to talk stocks back up.
There's no doubt that China's stock markets will eventually matter very much to the rest of the world. But first they need to grow, welcoming a wider array of companies. "China's equity market will become an important influence on the Chinese economy" and, by extension, the global economy, says Rob Subbaraman, chief economist for Asia at Lehman Brothers. But the lesson of last week is that China isn't there yet and won't be for years. Until then, Shanghai's bubbly bourse will likely remain what it is today: an internal affair.
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