Zhao Yanjing on China's Stock Market

Zhao Yanjing, “With the Huge Turmoil in the Stock Market, China’s Economy Reaches its most Perilous Moment”[1]

Introduction and Translation by David Ownby

Introduction

Zhao Yanjing is a Professor of Urban Planning at Xiamen University and a frequent commentator on national and international affairs. Notably, he has written a great deal about China’s real estate crisis (see here, for example), arguing essentially that central authorities should do everything possible to avoid bursting the bubble, because debt, credit, and bubbles have fueled China’s expansion over the course of reform and opening. There is more to his argument, of course, but he is arguing against people who insist on “market fundamentals” and “balancing balance sheets.” Zhao’s experience as an urban planner has allowed him to understand the miracles debt and credit can deliver, and he sees the intelligent use of these mechanisms as crucial to continuing economic development.

The text translated here is similar in that it praises China’s intervention in what Zhao sees as an undervalued Chinese stock market. In Zhao’s eyes, this is the first battle in a war to revitalize the entire Chinese economy, and he hopes that a bull market will provide the capital China needs to bring real estate and manufacturing back to life.

The stimulus package of September 24 was in fact one more in a long line of such (see here), and to date, the results have been disappointing. I had lunch with Chinese friends on September 24, and the government action was all they could talk about. “I don’t know what took them so long,” one of them said. “Everyone knows that this is the only hand they have to play, and yet they’ve held off for months!”

In fact, I was in China for the month of September, and almost everyone I talked to was worried about the economy. If, like my friends, everyone was focused on this stimulus package, and if, as appears likely, the package produces meager results, then the mood may turn sour. More than one person told me something like “life is great in China as long as you don’t talk about politics, but if the economy goes south, everything will be political.”

Translation

The Battle has Just Begun!

I never predict whether the economy will rise or fall and prefer to analyze how the economy may rise or fall. The same is true of the stock market. On September 24, China’s Central Bank was first out of the trenches, followed by a Politburo meeting which sounded the call for a general attack, the first battle targeting China’s long-undervalued stock market. An unexpected triumph shook the world, instantly reversing the expectations of the entire market, and proving that choosing to launch the war with an assault on capital markets was a wise decision. When a whale rises, everything else falls, and a trend began to appear in which capital heretofore not optimistic about China began to “withdraw from overvalued markets and turn toward severely undervalued Chinese assets.”

However, the momentum generated on the stock market was blunted by the long National Day holiday, and a number of opposing forces started to arise. First, US employment data was better than expected, which prompted the Federal Reserve to suggest that further cuts to interest rates were not in the offing, and Larry Sommers hinted that the recent cut of 50 basis points had been too hasty.

Then, over the holiday, the idea spread that China’s bull market was in fact a “mad cow,” a bull market not supported by economic fundamentals. This seemed especially true after the National Development and Reform Commission(NDRC)press conference, as people came to believe that the measures taken were inadequate and that the stock market would not perform that well after all. The stock market began to slow after closing, and especially Hong Kong stocks and Chinese concept stocks fell against the market trend after the markets closed in China, prompting investors who were originally prepared to go all in on the Chinese stock market to think again.

The next few days will be the most perilous time for the Chinese economy. Should the Chinese economy lose its hard-won momentum, subsequent battles will be much harder to mount, and the market will lose faith in the government. At this juncture, the Central Bank – the sole force having penetrated deep into enemy territory – must remain absolutely resolute and cannot waver. The bank must be like the Hong Kong Monetary Authority, which in 1997 used public money to invest in blue chip stocks to punish and deter currency speculators. Although there are no short sellers in the current situation, playing offense or defense makes no difference in recapturing the power to set prices in the capital markets.

Some people may say that government intervention will undermine the basic rules of the stock market so that investors will no longer believe in the market. This view was prevalent when the Hong Kong Government bailed out the market, and it turned out to be a load of nonsense. Not only did Hong Kong retain its position as a world financial market, with public funds making huge profits, it also became a standard tool for the rescue of the economies of developed countries in 2008. The Bank of Japan has even routinized the direct purchase of stock market ETFs [exchange-traded funds], which has become a daily tool for directly injecting liquidity into the market.

Still others say that a “mad cow” market is unhealthy, because it is not supported by economic fundamentals and will break down sooner or later. There is no definite rule as to whether a “mad cow” is better than a “slow cow;” everything depends on the health of the economy. But a critically ill patient needs a shot to the heart, in the same way that a “mad cow” is necessary to save today’s market. The crisis of China's economy is unprecedented, and the “mad cow” stock market the likes of which we have never seen is in fact nowhere near “mad” enough for what the economy as a whole truly needs.

The argument that “a wildly rising stock market is not supported by economic fundamentals” is also wrong. In times of economic crisis, we should use the stock market to change economic expectations and reverse economic fundamentals, rather than waiting for economic fundamentals to improve to support the stock market. Some people argue that: “I have not heard of any country relying on the stock market to boost the economy,” but this is because they misunderstand what we call the “virtual economy,” and they hence ignore its capacity to counteract the effects of economic fundamentals. It is true that the strong stock market rally is not supported by economic fundamentals at the outset, but following large cash infusions, market liquidity will go from scarce to abundant, consumption and investment will come back to life, which in turn will increase tax revenue and business profits, finally producing the “fundamentals” necessary to shore up the market.

Between the stock market rally and the arrival of increased profits and improved economic fundamentals, there is a bubble period of inflated stock prices, at which point the central bank must resist the pressure to cash out and wait for economic fundamentals to return. Only then should the central bank gradually withdraw and switch to indirect control through interest rate management. At present, China's stock market is starting to enter this dangerous bubble period, which is when the war will begin in earnest. The central bank should be prepared for a large amount of capital to cash out and leave the market, and despite this should absolutely not give in to the fears produced by cost pressures, or of being accused of increasing debt. Cashing out injects liquidity into the market, and as this money enters the market, demand will increase, enterprises will turn a profit, and the macro economy can start to repair itself. The purpose of the central bank is to inject liquidity into the market.

Some people worry that drastic rises and falls in the stock market will trigger a transfer of wealth from retail investors to institutions and aggravate the polarization between rich and poor. This is all the more reason for the state to be in the market. This time, institutions took over a large number of stocks that were sold by the retail investors who were originally hung up. Now that stock prices have soared, it is these institutions that have cashed out in advance, while most of those who are trapped in the market are retail investors who have just rushed in. So if the central bank injects liquidity into the market at this point, it will flow to these retail investors. Allowing retail investors to cash out on the back of the central bank is what many people advocate as a means of directly distributing money to stimulate consumption. In addition, unlike "helicopter money," the liquidity released by cashing out in the stock market is backed by assets.

It is important to emphasize that the size of a debt per se doesn’t matter - as long as there are corresponding assets, even a huge debt is not a problem; conversely, without the necessary assets, even a penny is a bad debt. Measuring the health of a country’s debt in terms of the ratio of total debt to GDP is as meaningless as measuring the health of a person in terms of the ratio of body temperature to body weight. The central government's constraint on debt is taxes. Debt is sustainable as long as taxes increase faster than the interest on the debt. And whether taxes go up or not depends on whether liquidity increases or decreases in the market.

The last person in the stock market who should be worried about cashing out is the central bank, because increasing liquidity is the goal of the central bank's monetary policy, and the more people cash out, the more liquidity there is in the market. The goal of preventing major shareholders from cashing out is not to stop all cashing out, but to stop a few people from grabbing the benefits from everyone else, so that more people can make money from the stock market.

One of the reasons for the poor stock market reaction to yesterday's NDRC press conference was the belief that the fiscal policy introduced by the central government was not strong enough. This judgment is based on an incorrect interpretation of our current economic problems. In previous bailouts, China's main tool was massive investment in infrastructure through fiscal expansion. But this time is different, because China's infrastructure has been completed, a large number of assets are not generating sufficient cash flow, meaning that when debt repayment hits its peak there will inevitably be a break in cash flow. In particular, the real estate recession led to a sharp contraction in cash flow in the market.

Once cash flow returns, the economy will immediately come back to life and will rebound much faster than in previous bailouts - because any investment drive requires a minimum construction period, but in this case the assets already exist, and so as long as there is money, the economy will be like a drowning person who is revived by a breath of oxygen. China's economy is complex, but there is only one cause for its current crisis, and that is the lack of liquidity in the capital market (caused especially by the real estate market recession). In this case, as long as enough liquidity is created through the capital markets, even if fixed investment does not increase massively, the economy may well rise from the dead, and confidence in the private economy will be restored. In a word, monetary policy can achieve its macro-objectives without relying on fiscal policy.

Still others worry that an overvalued capital market will see a large-scale capital outflow given the huge interest rate gap between China and the United States. I am worried about the opposite – that the booming Chinese stock market will attract external capital to come in and buy cheap. The Chinese stock market is currently the world's lowest valued capital market with a huge capacity for growth. Other countries' stock markets have either already reached their peak and need to keep spinning yarns to maintain their position (such as in the United States) or they have no corresponding assets all and are solely sustained by growth expectations (such as in India). As long as China's stock market is rapidly revalued, all of these capital markets could participate. What China should prevent is foreign capital coming in too early and plowing through China's undervalued assets. It is important to keep the maximum possible liquidity created by this stock market appreciation within China.

The stock market is only the first battle in China's economic offensive, a part of the war, but not the war itself. Whether the stock market goes up or down does not depend on its own valuation but reflects the needs of the war as a whole. Only by looking at the overall battlefield can one understand the macro-significance of the rise and fall of the stock market. Once the first shot is fired there is no turning back. Once the troops have surged forward, they must continue until victory, and never give up halfway. At this critical juncture, the stock market must rise, no matter the cost. Once the stock market stands steady, real estate will follow, consumer demand can be repaired, and the fundamentals of the economy may return to health as well, in turn giving the stock market a more solid foundation.

Notes

[1]赵燕菁, “股市巨震, 中国经济来到最为危险的时刻,” republished online in 文化纵横/Beijing Cultural Review on October 10, 2024. Originally published on October 8, 2024 in存量规划前沿.