From the May 30 edition of the Wall Street Journal (on the opinion page in the print version):
Though it's hard to believe, China's sickly mainland bourses are the best-performing in Asia this year to date...
In normal economies, stock prices are based on expectations of a company's future earnings. China, however, isn't a normal market. Sure, mainland company profits are up slightly. But Chinese corporate profit forecasts -- when they're available -- are often linked closely to expectations of how the government will regulate a sector or company. Not to mention the poor corporate governance, lax financial disclosure and haphazard regulatory environment that lace the mainland's markets...
Foreigners aren't behind the recent euphoria. China's qualified foreign institutional investor program, which lets the waiguoren punt alongside the locals, is worth only about $6 billion. That's doesn't count for much in a market of around $450 billion. And not all of that foreign money is invested in stocks, either.
That leaves China's famed domestic punters, who may feel emboldened by other Asian stock market gains over the past few years. Or perhaps, given their limited investment options, China's investors simply can't think of anywhere better to park their cash...
The interesting question is, where would that domestic saving go in the absence of the extensive capital controls that support the PBoC's ability to so tightly control the value of the yuan? Anyone want to bet it won't be in China?
Bread Setser raises a related issue in a very interesting post on the Chinese government's attempts to recapitalize its (presumably) ailing banking system with its very nice collection of dollar-denominated assets. Says Brad:
That is the problem with giving the banks the country’s foreign exchange reserves. It creates a currency mismatch on the banks’ balance sheet. Potentially a big one. RMB deposits need to be matched with RMB bonds and RMB loans. Not dollars or Euros. If the banks get dollars or euros, and the dollar or euro depreciates against the RMB, good banks will become bad banks quickly. Depreciating assets are not a good thing for a bank...
There is one set of circumstances where China’s bad banks could require China to use its dollar reserves. It goes like this.
Chinese bank depositors lose confidence in China’s banks, and start to withdraw deposits from the banking system in mass. That would be a big change from the very strong deposit growth we are observing right now. But it could happen...
As depositors pulled their funds out of the banks, they would end up holding a huge stash of RMB cash. And they might want to convert that to dollars or euros.
China has capital controls, so this isn’t easy. But let’s suppose for the sake of argument that the controls are lifted. The central bank maintains a de facto peg – so the depositors could sell their RMB to the central bank for its dollars...
Bingo –
Two key points:
First, the dollars are useful if Chinese citizens want to pull their funds out of China. ..
Second, with a current account surplus of $150b (and growing) and net FDI inflows of $50b, Chinese deposits could send up to $200b a year without requiring the central bank to dip into its existing reserves at all. Rather than financing reserve buildup, China’s enormous surplus in its basic balance of payments would just finance capital flight.
Of course, Brad thinks -- and he is surely right -- that there are a lot of other fairly good candidates to which that capital could eventually fly. But I'd say you'd want to at least imagine that these arguments bound the downside.