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2 SPEAKING
FREELY Crazy markets and China's
savings By Mark A DeWeaver
Speaking Freely is an Asia Times
Online feature that allows guest writers to have
their say. Please click hereif you are interested in
contributing.
April and May saw
the first two-month contraction in Chinese
household bank deposits in six years. From a total
of 17.5 trillion yuan (US$2.3 trillion) at the end
of March, households withdrew
167.4
billion yuan in April and a further 278.4 billion
yuan in May.
As these withdrawals
coincided with a period of frenzied retail
investment in the stock market, it seems clear
that a big portion of this money was used to buy
shares. In June, amid a 7% decline in the Shanghai
Composite Index, household deposits rebounded,
with an increase of 167.8 billion yuan bringing
the quarter-on-quarter decline for the end of the
second quarter to 1.6%.
Many commentators
have seen this large and rapid shift in the
allocation of national savings as cause for alarm.
Some have argued that the withdrawn deposits are
being "tied up" in the market, ie, have become
unavailable for investment or consumption. Others
believe that increases in Chinese households'
exposure to stocks increase the risk that a crash
could result in social unrest.
A June 2
article in Taiwan's China Times claimed that
demonstrations on the scale of Beijing's 1989
Tiananmen Square protests could not be ruled out.
Not to be outdone, the website of the British
newspaper The Daily Telegraph even warned that a
"downturn in Chinese markets could spark social
unrest across Asia".
While claims like
these have become increasingly common, there is
surprising little support for them. As Austrian
economist Fritz Machlup showed more than 75 years
ago, as long as there are new issues, capital is
unlikely to be "tied up" for long. And there is
simply no precedent for serious social unrest in
China resulting from a drop in the markets.
Liberating trapped cash The
idea that the stock market can tie up capital has
a long history, going back at least to the 1920s.
Machlup considered this possibility in a 1931 book
called The Stock Market, Credit, and Capital
Formation. While many people still seem to
imagine that funds used to buy existing shares
must necessarily be withdrawn from the "real
economy", Machlup emphasized that we can't draw
this conclusion without first considering what
happens to the proceeds of sales.
For
there to be any question of capital being trapped
in the market, some seller must either (1) leave
her sales proceeds in a brokerage account or (2)
use them to buy other shares. In the first case,
the increase in the seller's cash balance is an
increase in the broker's liabilities (for internal
control purposes, at least, if not on the actual
balance sheet). The offsetting asset is unlikely
to be vault cash. If the broker deposits the funds
with a bank or lends them out in the money market,
the money withdrawn by the buyer (to purchase the
seller's shares) will return to the aggregate
credit supply.
Chinese brokers have also
been known to violate prohibitions on the use of
customers' cash balances for proprietary trading
or margin lending (sometimes losing massive
amounts of client money as a result). If this
happens, the situation is the same as in the
second case, but with the broker itself or a
borrower rather than the seller using sales
proceeds to buy shares.
It's clear that
sales proceeds won't be tied up if they are not
reinvested. One way or another, they will return
to the credit markets. This leaves the more
interesting possibility that capital might be tied
up in a lengthy chain of transactions among
speculators who reinvest after each sale (or whose
brokers routinely buy shares for their own
accounts or make margin loans with their clients'
funds).
One way to visualize this is to
imagine a line of traders continuously exchanging
suitcases full of cash for others containing share
certificates. As long as no seller ever takes out
her cash and spends it, the money in the suitcases
will be "stuck" in the market. (The traders need
not always be the same individuals - the story
will be the same if people join or exit the line.)
While this is theoretically possible,
Machlup pointed out that in practice it's quite
unlikely that business owners would fail to get
access to these funds through new share issues.
After all, there would be nothing to stop an
entrepreneur from joining our hypothetical line of
speculators with a suitcase full of shares in her
own company. Having exchanged this for a suitcase
full of money, she would go home and invest in her
business, thus liberating the trapped cash. The
market might tie up capital temporarily, but only
until a sufficient supply of new stock was made
available.
Given the huge volume of
initial public offerings (IPOs) coming to market
in mainland China these days, both from companies
not yet listed and those already trading in Hong
Kong, there seems little reason to think that much
capital can be tied up in the market for existing
shares. It thus seems quite unlikely that "the
stock market can help absorb some of the excess
cash in the economy and help relieve the pressure
on inflation", as China Galaxy Securities
economist Teng Tai told the Shanghai Securities
Times on June 7.
Nor does it make sense to
say that the movement of household savings from
bank to brokerage accounts is a "challenge for
policymakers" because "the money flowing out of
banks is largely bypassing the real economy", as
James Areddy wrote in the June 27 Wall Street
Journal.
One can only conclude that new
editions of Machlup's book, in both Chinese and
English, are long overdue.
Unfairness,
corruption and unrest Failing to remember
that there are two sides to every transaction
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