Chance to take stock

25 January, 2016


By Chandran Nair
South China Morning Post

China’s stock crisis gives Beijing an opportunity to create a market suited to its own unique situation

Chandran Nair says policymakers should seek to protect the legions of retail investors, and their life savings, from the vagaries of the market

The global economy seems, once again, to be in unchartered waters. No one quite knows what is going on but recent explanations have included the historic low price of oil, the US Federal Reserve’s interest rate hike and China’s slowing economy. The latter has lately come to the fore, as China’s stock market troubles have made world headlines for all the wrong reasons: above photographs of elderly Chinese watching images of collapsing share prices. This is an image we don’t see with other stock market crashes around the world: weeping traders, maybe, but not weeping grandmothers.

China’s market volatility has become the convenient scapegoat for global economic unease, providing another opportunity for all and sundry to blame Chinese regulators and particularly its not-so-free market. But even if Chinese officials think this is unfair finger-pointing, they should view it as a historic opportunity to take stock and redirect its still nascent stock market so that it truly serves its economy in the long term, given China’s unique position in the world today.

It is not clear that Beijing knows how to resolve this latest market volatility. Chinese regulators have admitted they had no experience of managing the circuit breaker mechanisms put in place after the last stock market crisis, and have accepted that these have only deepened the problem. This situation does not make Beijing look good.

It is perhaps not too outrageous to ask why China even bothers with a stock market. After all, even its best-known company, Alibaba, did not list in China when it went public. Beijing has placed much of its economic and political credibility on a strong stock market driven by the desire to match those in the West. This emulates a similar belief in the West that a strong market is a symbol of national prestige: one need only look at how Western media worry when their markets do poorly, and crow when Chinese markets stumble.

The financial policymakers in China would do well to remember the central purpose behind shares and stock markets: they are a way for companies to raise capital from the general public by opening up their ownership structure. The theory is that, in exchange for investments, investors get a regular income through dividends when the stock performs well. A market allows an investor to “cash out” when he or she needs money, perhaps for emergencies, large purchases or retirement income. Implicit in this is taking a long-term view.

A stock market is not – or should not be – a casino for daily speculation, despite today’s rapid hour-to-hour, or even second-to-second, trading. The “flash crash” of May 2010, where US stock markets collapsed and recovered in a matter of minutes, is an extreme example of this high-speed, high-stakes trading.

There is little evidence that speculation and stock picking has any real benefit, either to an economy or individual investors. Some people may enjoy the act of researching, analysing and “picking” stocks. But this, to be blunt, is a more intellectual form of gambling. Countries – and especially large developing ones like China and India – should not make more accessible gambling a central element of economic policy, enticing naive punters from their new middle class. They now have an opportunity to reshape the stock market landscape in China and ensure it serves its primary purpose and not be the casino it has become.

China’s stock market is unique in that most of its investors are retail investors – 80 per cent of Chinese stock market transactions come from individual traders, rather than funds or financial institutions. This fosters volatility, as rumour and feelings of unease can easily build to a wave of fear, and thus collapsing share prices. Beijing is stuck with a “damned-if-you-do, damned-if-you-don’t” scenario: let share prices fall – and scare millions of investors – or take action to stop falling share prices – which only proves to investors that there is a problem. Rather than let its people gamble away their savings on the stock market and sow the seeds of social instability, the Chinese state should protect them from the vagaries of a stock market that is, on balance, arguably not a net positive.

This is not in any way to suggest China should get rid of its stock markets – it probably could not, even if it wanted to – but it can certainly create one with Chinese characteristics. The Chinese state, due to its larger presence in the economy, actually has more tools at its disposal than its Western counterparts, who have largely failed to contain the excesses of current market realities.

For one, China can limit the number of people who could be affected by – or could contribute to – volatility in the stock market. This could be as crude as barring those with low savings and incomes from taking part in retail investing. More indirectly, a fixed levy on new retail investors would only allow investors with enough wealth to shoulder a loss on the stock market.

China can also discourage the short-term speculation that fosters damaging market volatility. There are many ways to achieve this, but the simplest would be by imposing a small tax on financial transactions. This would be an effective break on rampant speculation and would encourage longer-term views on holding shares and assets. Chinese officials, including the top foreign exchange regulator, have already suggested using a transaction tax to curb speculation. Unlike other countries, where vested interests and economic orthodoxy have limited the available options, the Chinese government is not constrained by fundamentalist free market ideology and has policy flexibility to impose these restrictions.

Thirdly, China could require certain types of investors and certain type of stocks to be held for a minimum period, thereby discouraging many from using the market to gamble. This will help to make gambling on stocks a thing of the past.

China is the first emerging economy to build a stock market of this size, and with such a large population, which brings unique challenges that have no counterpart in Western orthodoxy. Rather than adopting a contemporary Western architecture, which privileges efficiency and speed over stability, China must develop its own path. A slower market would encourage the responsibility that developing countries and populations truly need. China does not need to ape the Hong Kong stock market or strive to make Shanghai or Shenzhen markets bigger. China can instead combine a slower, more controlled stock market with Hong Kong’s more freewheeling volatility and links to international markets: perhaps a structure of “one country, two markets”?