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Q&A: Professor Mary Lovely on China’s Market Volatility
The recent volatility of China’s stock market has made for a rough ride for Chinese investors and worried exchanges worldwide. Maxwell School Economics Professor Mary E. Lovely, who studies the Chinese economy and China’s economic growth, provides some insight into the market’s instability.
Lovely, who was a co-editor of the China Economic Review and recently returned from presenting at a conference in China, is chair of the International Relations Program and a Melvin A. Eggers Faculty Scholar. Her work includes a focus on international trade and Chinese firms, and she is beginning a research project on state-owned enterprise reform.
Q. What forces are in play during this time of decline/collapse in China’s stock market?
A. Since the beginning of the year, the Chinese markets have seen rapid price increases—they rose about 150 percent until early June. The collapse began on June 12, over concern about slowing economic growth and the spreading belief that the steep market incline was a bubble. Everyone tries to get out at the same time, causing market valuations to fall precipitously. The markets have lost almost a third of their value since mid-June, although they rose a bit yesterday. It is important to recognize that the Chinese markets are still up about 70 percent year-on-year. So whether individual investors lost everything or not depends on when they bought their stock.
Q. Can the Chinese government’s efforts to stabilize the market work?
A: The Chinese government has many tools with which to stabilize the market. It has intervened in a number of ways, some of them quite constricting. Its first response was to reduce interest rates, in an attempt to boost expectations about future economic growth. As markets continued to fall, the government took an increasingly strong hand. Trading in many stocks, by some measures about one-half of all stocks in small and medium enterprises [SMEs], has been suspended. There is a ban on sales by insiders, with relaxed restrictions on purchases by insiders to encourage buying. State enterprises are buying back their own stock, also pushing against the market. These actions tend to make funding cheaper for large enterprises, more difficult for SMEs. For the immediate future, however, there is a suspension of any new IPOs.
The government has also moved to ensure liquidity for brokerage firms. They have also loosened margin requirements, so that for now the firms are not calling in margin loans that in ordinary times would wipe out stock holdings for people who bought stock by borrowing against them. As we saw yesterday, the market did “stabilize” but that is because of extraordinary intervention, not a change in market fundamentals. Some observers compare the situation to a “suspended avalanche” in the sense that the stock prices of SMEs are simply in suspension and they will continue falling if allowed to be traded freely.
Q. Is this a correction that needed to occur?
A. One view is that the market was overvalued due to Chinese policies that reduced household access to other savings vehicles or that made other forms of saving less desirable than stocks. For example, many households have placed their savings in real estate, but overbuilding has led to softer markets in some cities and real estate is not liquid and has high transaction costs. Markets are a desirable alternative: a saver can get into the market with smaller stakes, have the feeling of control since they can buy and sell at will, and may feel that the government will reduce risk. In fact, oversight of corporate governance is weak and investors may do very little research on the companies they are buying believing they cannot fail because the government will step in to stabilize any fall.
Q. What impact might this have on China’s economy? And on the U.S. and international markets as this plays out further?
A. If stock values do not rebound, households may perceive a permanent decline in wealth and slow down the growth in household expenditure. Chinese households are notorious savers—they save about half of their income. The macroeconomic rebalancing that China is attempting—reducing reliance on export markets as a source of growth and increasing reliance on domestic consumption—requires households to save less and spend more. The stock decline may make this rebalancing more difficult. External markets cannot be expected to increase their absorption of Chinese goods at the rate they did over the past decade. Consequently, Chinese economic growth may slow down further, below the growth of 7 to 7.5 percent that was already a slower pace than the past.
Given that, however, the vast share of Chinese household wealth has not been placed in the stock market. According to one estimate, about 15 percent of the assets of Chinese households are in the stock market. Household holdings of real estate, for example, are far larger. The impact on Chinese domestic spending may be less dire than feared. If economic growth slows further in China, however, there will be an impact on commodity exporting countries, such as Australia, and on capital equipment exporters, such as Germany.
The impact on the U.S. market may be positive as investors turn to safe havens. Chinese shares traded outside the mainland have not fallen that far, and only an estimated 4 percent of the Chinese market is held by foreign investors. The vast majority of losses will be felt by Chinese citizens, not foreign citizens.