China has what Turkey had in the late 1980s
I started my career as an economist at the Capital Markets Board of Turkey. It was the 1980s. I was fresh out of school and excited to be part of a milestone in my country’s economic policy: opening the Turkish stock market to foreign investors.
When China’s stock market indices took a dive last week, I inevitably started making comparisons to those days. It’s hard for governments to start respecting markets. China detained and criminally charged around 200 people for spreading false rumors about the stock market and economy. A financial journalist apparently went on TV and tearfully confessed his crimes. But that is how you learn about this game. I think though, that the technical aspect of last week’s events has not been discussed enough. Keeping that in mind, let me give you a new perspective on China’s “Great Fall.”
China has two kinds of shares: type A and type B. Type A are the shares of inland companies that are denominated in R&B, which is China’s currency. China has only recently allowed foreigners to trade these. What does that mean? It means you can now dump your shares on foreign investors. That could be a profitable transition period, mind you. A similar thing happened in Turkey when we opened the Istanbul Stock Exchange to foreign trading. We had a volatile period, followed by a steep fall. But China’s case might even be more volatile than the Turkish one. It turns out that 85 percent of Chinese stock market investors were individuals, which is never a recipe for stability. Though Turkey opened up to foreign investors in 1989, short selling as a portfolio management technique was only allowed after 1992. China let it happen right away, which combined with individual investors, was a recipe for volatility.
The macroeconomic background of the great fall is of course important. Yet the extent of the movement is determined by technical details. The Chinese economy appears to be slowing down, simply because it is bigger. When something is bigger, the same amount of increase will be indicated by a smaller percentage of growth. When China’s economy was worth hundreds of billions of dollars, it could sustain double-digit growth figures. Now that it is a 10 trillion dollar economy, the same amount of growth won’t show up as the same rate of growth.
Yet the volatility we recently observed in China is also due to the timing of financial liberalization measures. Here is another culprit for you to think about. It has been happening in Turkey very recently as well. Look at the end result. By buying stock of Chinese companies, China is making them public again. It is deprivatizing.