JULY 11, 2015 — Here’s what some scorched investors in China are muttering as they tally their losses: That’s the last time I take stock market advice from People’s Daily.
Go ahead and chuckle at the irony of China’s official Communist Party newspaper masquerading as The Wall Street Journal. It does sound contradictory. Forget all that propaganda in Mao’s Little Red Book, buy blue-chips. Never mind the government’s five-year economic plan, who’s got a hot tip on a tech IPO?
More seriously, China is struggling through a crucial moment on its journey from communism to free market economics. We hope the government learns the right lesson: The Western-born system is designed to operate as a fair and open competition. This creates winners, losers and, yes, sometimes chaos, but over the long haul, capitalism generates the most value for the most people. If you try to manipulate the results, you’ll destroy trust — and wealth.
The drama in China involves the incredible run-up of its stock market over the past year, and the crash that followed. We’re talking a leap of 60 percent to as much as 150 percent for the Shanghai and Shenzhen exchanges. This was giddy stuff even for an economy that is changing the world. It was also unsustainable because China’s fundamentals don’t justify the numbers. The economy’s growing at maybe 7 percent, not the rocket ship-level 10-plus percent of past years, and the real estate market is slumping. Local governments are awash in debt.
What happened? China needs a robust stock market to fund corporate investment and juice spending by consumers. Over the past year, the government cut interest rates to spark economic growth, and people were looking for better investments than real estate. So they plowed into the markets. Newbies were a big part of the trend, and many of them bought shares with borrowed money.
The government liked the results, encouraged them, maybe even guaranteed them. At least that’s how it looked to many investors who saw the state-run media’s cheerleading. In April, Reuters translated a commentary from the People’s Daily website that said the bull market “has just begun” because it “has support from China’s grand development strategy and economic reforms.”
When the party tells you the fun’s not over, what do you do? Keep buying stocks.
Then, inevitably, the bubble burst. Shares tumbled by one-third over the last few weeks, wiping out trillions of dollars of wealth. Markets are still up for the year, but nerves are frayed.
There’s also new concern about the government’s ability to manage economic growth. That’s because of the heavy-handed way officials reacted to the crash: They are doing everything they can to stop the slide, instead of permitting the correction to play out.
Companies have been allowed to suspend trading of their shares and IPOs are canceled. Big shareholders, executives and directors are being told not to sell. Government funds are pouring money into the markets while banks have eased lending requirements to encourage share-buying. Police are threatening to investigate short-selling.
Early signs are that the government may wrestle this panic to the ground. China has the money, and the party controls the levers of power. If the crisis subsides, that’s good for Chinese investors. People outside of China have little or no exposure to Chinese stocks, limiting any contagion effect, so Americans are probably OK. Yes, the Chinese economy takes a hit, but nothing catastrophic.
The future is more uncertain. China won’t fulfill its destiny as a powerhouse contributor to globalization until it fully transitions from a closed, state-run economy to an open-market economy. Money needs to be put to its best use. Banks and corporations can’t be driven to make reckless decisions to support political aims. Investors have to trust what they see, and read, and not fear being manipulated by unseen hands.
Chinese President Xi Jinping understands this. The party vowed in 2013 to allow markets to play a “decisive” role in the economy by 2020. There weren’t many specifics attached, and to be fair, Western countries don’t always follow free market principles either: The recovery from 2008 was hardly perfectly executed.
In China’s case, the government seemed committed to reform but now stokes legitimate doubts about its resolve. If the party is willing to toy with market performance on the way up, and on the way down, where does the meddling stop?