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The Shanghai Stock Exchange tumble - meltdown or not? |
By Julian Stargardt, Managing Director of Cambridge Business Group Limited
On 27th February, Shanghai’s Stock Exchange (SSE) fell by nearly 9%. This led to a slide of 3.5% on the NYSE and similar drops around the world. International media trumpeted a “meltdown” confusing events in Shanghai with what a 9% drop would mean in London, New York or any other market. It is not surprising and it should not be misinterpreted as a meltdown of China’s economy. The only surprise is the impact it had on the rest of the world and that is only surprising because the world is surprised by it. Remember that government participation in China’s economy, through ownership of commercial and industrial enterprises, accounts for 50+% of GDP. With massive active and direct participation in every sector of the economy, government influences economic issues in a way Western governments do not. This event is a refreshing wake-up call and dispels any doubts of China’s actual and potential global economic influence both as a country capable of deploying vast foreign currency reserves in foreign markets through state-owned commercial channels and as a nation of substantial private investors.
With market capitalisation growth of over 170% since mid-2005, a meltdown in this context would be a double digit collapse. In such a volatile market open only to mainland Chinese, a 9% drop is an adjustment. However, it soaked up a lot of liquidity and, to make ends meet, Chinese investors sold overseas investments..
China’s stock exchanges have more resemblance to casinos rather than to the New York, London or other exchanges. Punters “bet” on numbers. They rarely know the names of the companies they punt their money on, let alone the P/E ratio or any other fundamental about their investment. A further illustration of this aspect of the SSE is the price differential of 100% or more, according to JP Morgan Chase, between “A” shares of eight so-called “blue chips” available only to the Chinese and “H” shares available to overseas investors. Those differentials tell a story of a grossly inflated market!
Surely a 9% drop in a market that’s only open to local investors should only have local impact? This is wrong for two reasons. First, because overseas markets are not closed to China’s investors and second, because overseas markets are run by traders who are prone to baseless knee-jerk reactions. The first effect, the unreciprocated openness of international markets to China’s investors, leaves markets exposed to “Trojan Horse investments” in which an investor manipulates the market by inflating or deflating prices. The fall of international markets should be taken as a sign of China’s international economic influence. China invests far more internationally through offshore fronts and other intermediaries than is commonly acknowledged. The knock-on effect in the global market may have been triggered by Chinese institutions and wealthy individuals needing to realise overseas investments in order to shore up immediate and short-term domestic and international fiscal liabilities which were squeezed by the drop. Brokers witnessed unexplained sales of blocks of stocks and followed the trend by dumping shares so causing a worldwide market fall.
This event is proof of China’s global economic clout and capacity to move international markets and could be a harbinger of a true meltdown of China’s markets.
China’s markets are grossly inflated and, by international standards, poorly regulated. But it is questionable whether international standards apply to a market where ultimate regulation is in the form of government control through participation and changing “policies”. A true meltdown could lead to chaos. Chaos in China would have a ripple effect across the region and further afield. This could result in Galtieri Syndrome in which a desperate government looks for a populist military adventure to shore up support back home. Such desperation is unlikely in China but the possibility should not be ignored. At present, with a 50% share of the economy, the government can regulate by participation so long as the foreign public continues to buy “made in China”.
Events of 27th February 2007, illustrate the potential of China’s money to move world markets. It is a clear illustration of what China could do with its economic power. China has over USD1 trillion in foreign exchange reserves and 50% of the economy is government owned. Apart from manufacture for export, China’s economy is still largely closed to foreign participation and even those areas nominally “open” to foreign corporations are restricted by other factors which can loosely be described as “non-tariff barriers”.
Globalisation is not just a Western phenomenon. China’s rapid economic growth leads to a natural inclination for her to diversify risk and secure supplies. This takes the effect of increasing Chinese participation in foreign stock exchanges and in foreign direct investments especially in essential resources such as oil fields, iron and copper mines and in foreign technology. As China grows, we will see an increasing impact of China’s investments on international markets. With a trillion plus dollars to play with, China’s funds can be massively invested or suddenly withdrawn. The effects and influences of these investments could cause sudden market fluctuations which may give rise to trends followed by other investors.
Investments can be channelled through many different overseas fronts such as overseas companies not readily traceable to China. China’s overseas investments are generally beneficial as a number of US iron ore producing and smelting facilities bear witness. Having been closed down by their US owners, China’s investment revitalised local economies and employment by resuming production. Likewise, China’s investment in international markets has helped fuel capital gains and sustained growth and employment across the globe. Much griping is made about imbalance of payments between China and its export partners but China’s foreign investments partly address that, sometimes below the radar screen. Nonetheless, China’s participation in international markets has serious strategic implications for all markets because of state participation and it could be used hypothetically as a lever to influence events, opinions and policy in foreign countries. Relatively small scale sales of stocks led to a 3.5% fall on the NYSE. What would be the global impact of large scale investments or divestments?
China’s stock markets are largely closed to foreign investors and this shields those markets from foreign participation. So, even if a tit-for-tat foreign intervention in China’s stock markets were contemplated, it would be difficult or even impossible to execute.
However, China’s economy is peculiarly vulnerable to foreign market whims because China’s domestic economy is export driven. The domestic economy is small. The vulnerability of the Chinese economy to foreign market forces was demonstrated back in 1989 and the early 1990s when China experienced the economic consequences of the international outcry against the crushing of the Tien An Min Square student demonstrations. Public outrage across the world caused a major economic slow-down in China’s economy because people stopped buying “made in China” and companies stopped investing in China. This nearly happened again over the 1st April 2001 Orion EP-3E incident when a Chinese J-8 fighter knocked a US intelligence aircraft out of international air space causing the US plane to make an emergency landing in China. Had China been any more dilatory in returning the aircraft and crew, I believe there would have been a major outcry among the US public followed by another “don’t buy made in China” movement.
If we look back at China’s behaviour in a time of true meltdown – the Asian Economic Crisis of 1997-99 – China behaved as a good neighbour and a good global citizen. Faced with a degree of economic stagnation at home, China could have wiped the floor economically with other East Asian economies. Instead, China kept the value of its currency steady, effectively high against regional currencies and supported regional economies. Those are marks of economic good neighbourliness.
If we take China’s behaviour in the context of its long history, it has always pursued a position of influence and sought to foster trade. Sometimes this has had unintended economic consequences. At home, China’s government is careful to avoid economic issues which could lead to social unrest or disruption and as the bulk of stocks in many companies listed on the Shanghai and Shenzhen markets are still held by government, it is currently in a position to control the market to an extent.
China’s military continues to flex its muscles and to increase expenditure by double digits so incidents with international impact may occur. Likewise, crackdowns by government to control domestic public dissent might also lead to an international outcry with an economic impact for China.
The joker in the pack is Taiwan. Short of Taiwan declaring independence, I doubt if China will do anything to rock the boat in the run up to the Beijing Olympics. However, once the Olympics are over, all bets are off and I expect China to ramp up the pressure on Taiwan to accede to some kind of union. If the mainland uses military force and an international audience is repelled by such a move, it could have a serious impact on the Chinese economy.
Lenin wrote that “capitalists are so hungry for profits that they will sell the rope to hang them with”2. Is allowing the free movement of capital to the West from relatively closed economies such a rope or is it a method of building bridges to create a more peaceful and harmonious vision of the future for our small planet as a single, interdependent, global community in which goods, services and capital are freely exchanged? The answer to this question will be found in China’s future openess or otherwise both at home and as a member of the international community.
ENDNOTES
1 Cambridge Business Group Limited is a Hong Kong based international corporate advisory practice.
2 Bartlett’s Quotations.
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US Senators target low-tax jurisdictions |
Three US senators have introduced a bill to target what they say is USD100 billion in tax revenue lost each year through overseas “tax havens”.
The proposed legislation would impose tougher requirements on US taxpayers employing offshore planning, give the US Treasury the authority to take action against foreign jurisdictions that impede tax enforcement, stiffen penalties against abusers and close offshore trust loopholes, according to a summary of the bill released by Michigan Democrat, Carl M. Levin.
New measures would require hedge funds to establish programmes to combat money laundering and to efficiently track offshore investors, under guidance from the Treasury Department. They would also prohibit the US Patent and Trademark Office from issuing patents for accounting strategies intended to "minimise, avoid, defer, or otherwise affect liability for federal, state, local, or foreign tax".
"We cannot tolerate tax cheats offloading their unpaid taxes onto the backs of honest taxpayers," Senator Levin said in a joint statement with co-sponsors, Norm Coleman and Barack Obama.
The Treasury Department together with legislators in both houses of Congress have prioritised this year the reduction of the so-called tax gap, the difference between what individuals and companies owe and what they pay. The IRS has said that a study of 2001 tax returns shows that the tax gap is USD345 billion a year, only USD55 billion of which is recovered.
The bill, according to Senator Levin, is a "strengthened" version of a measure originally introduced in 2005 and is the product of a four-year probe by the Senate permanent subcommittee on investigations.
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