Wharton China Conference 2009
February 25th, 2009Over the weekend I attended a conference about China at the University of Pennsylvania’s Wharton School of Business.
I was on a panel discussing China’s capital markets.
Other panelists included Charles Chen from Deutshce Bank; Gavin Albert, a New York-based investor with Ardea Capital; and Seth Freeman, a professor at NYU’s Stern School of Business. Our moderator was David Ng, a finance professor from Cornell. Prof. Ng argued that it is a bad time to label China a “currency manipulator” and that doing so is not ultimately in the US’s best interest. Prof. Freeman argued that the financial crisis came from a lack of common sense regulatory restraints in US markets and that trust enhancement mechanisms can help China avoid similar mistakes. Mr. Chen boldly suggested that China should develop a market for credit default swaps, the “weapons of mass financial destruction” that played a role the US meltdown. He argued that making them exchange-traded would make them safer. Mr. Albert talked about the promise of some investments in China, citing a number of examples from China Resources (Hua Run).
Here’s a recap of what I said:
After I got the invitation and started thinking about what I’d like to say, naturally I thought about things I’ve said at other conferences and previously published about China and its capital markets.
Two concerns struck me as I thought about leveraging my earlier material as a starting point for my remarks at this conference.
First, I worried that my previous claims, arguments, observations and analysis might now be outdated because of changes that have occurred in China. Many of the transformations in China have been so profound and rapid that it’s easy for a returning visitor to feel disoriented, as probably most of the 300+ participants in the conference have experienced. I confessed that although for a few years I read virtually every utterance of the China Securities Regulatory Commission (CSRC), recently I’ve become less mesmerized with following the details because in this area so little seemed to be changing in a fundamental way. For years people have talked about lots of dramatic changes for China’s securities markets, but very little seems to move forward. For example, people in China have for years talked about allowing more private companies to list on a Nasdaq-like SME board or “growth enterprise market” (a chuang ye ban), but nothing has yet happened. (There is now a special “section” of the Shenzhen exchange, but companies on it remain subject to the same listing requirements and government approvals as the companies on the main boards). Another reform idea that has been discussed is to allow foreign issuers to list shares inside mainland China. Years ago it was rumored Unilever would be the first foreign firm to list on one of the mainland’s exchanges; recently the NYSE has been touted as the leading candidate to be the first. But so far no foreign firm has shares publicly trading inside the PRC mainland. Other reforms that have been discussed are to let foreign capital come into the mainland markets in a more significant way, allow PRC investors to invest outside of China, create more robust shareholder rights, create more robust bond markets and allow diversification of financial products. These and many other reforms seem stalled or have been adopted in only modest, tepid forms. (Yes, they have created a QFII system and a QDII system, but both are subject to tight constraints; the fundamental structure of China’s stock markets has remained essentially in tact). Thus the invitation to this conference prompted me to review recent developments to determine whether or not there have been any disorienting recent changes in China’s capital markets. After doing so, I determined that still not much has fundamentally changed within China to alter my previous views about its securities markets.
The second concern I had is that even if China hasn’t changed a great deal with respect to how it regulates its stock markets, the world has changed a great deal recently, particularly since mid September when the failure of Lehman Brothers and other events threatened to bring the global financial system to its knees. I said that in that context, my previous advice to China and analysis of its financial sector absolutely needs to be revisited. I will momentarily summarize, at a very general level, the critique I and others have previously made of China’s financial sector. But given the current state of the world—the basic narrative of which is that the American financial sector has run over a cliff and threatens to drag the whole global economy with it—I feel I must acknowledge the elephant in the room . . . I must contextualize my critique and put it in an appropriate cloak of humility.
The critique of China’s financial sector espoused by me and others is generally as follows:
China’s financial sector is broken. It does not efficiently allocate capital. Both China’s banking system and its securities markets do not get capital to promising new ventures and entrepreneurs but instead funnel capital from the hard-working, productive savers in the economy to the value-destroying parts of the economy, namely state-owned enterprises. I said that others have argued that this value-destroying financial sector not only constitutes lost opportunities but also creates grave risks in the Chinese economy as non-performing loans build up in the banking system. Some have even argued this could lead to a “coming collapse” of China. The remedies proposed have included suggestions that China massively recapitalize its banking sector; impose hard budget constraints on firms (let SOEs go bankrupt); rely more on market forces rather than government interference to make lending decisions; and let investors, issuers and independent exchanges determine which firms can list, not the government. I and others have argued that China needs stronger, more independent courts to enforce meaningful shareholder protections, that China’s stock exchanges should be more autonomous, and that PRC government should not choose winners and losers but let markets sort things out. [In fact, a few years ago at a conference on derivatives, I argued that China should let the market decide what products will be developed, not have the government mediate financial innovation.]
Now, while I still believe that China’s approach to its financial sector, particularly its stock markets, inhibits certain goals China has (such as fostering innovation), all this advice to China has to be seen in the context of what’s happened lately outside of China. Now it is the United States that is massively recapitalizing its banks. It is the United States’ financial sector that has produced toxic assets the buildup of which has harmed our own economy and threatened to make the whole global economy freeze up. It is the United States where the largest US financial institutions may need to be outright “nationalized.” It is the last US Treasury Secretary who decided on an ad hoc basis to save certain firms, not others, and to massively intervene in markets, picking winners and losers and not imposing hard budget constraints on value-destroying firms. It is the US that is taking money from taxpayers (and future taxpayers especially) and transferring it to the value-destroying parts of the economy like the US auto industry and a financial sector gone wild. We are ourselves now moving sharply away from deregulation and increasing the role of government in the economy. I am not a fan of all these measures, but given that they are being taken it is unseemly, to say the least, for an American analyst to propose China unleash the creative destruction of markets and not heed temporary exigencies or “externalities.”
I noted that Newsweek‘s current cover story is titled “We’re All Socialists Now.” I mused that perhaps we can now talk about “socialism with American characteristics” (you meiguo tese de shihui zhuyi).
I joked that it might be time for US Treasury Secretary Geithner, US Fed. Chairman Bernanke, Economic Advisor Summers and other top officials from President Obama’s administration go to China on an investigation trip (to “diaocha yi xi“) after the fashion of the many, many groups from China that have traveled abroad during China’s reform era to get ideas for managing an economy in the midst of a difficult, complex transition that has incoherent or uncertain ideological underpinnings.
I connected the ad hoc US actions—in bailing out AIG but not Lehman and arranging shotgun marriages for Bear Sterns and Merril Lynch—to Deng Xiaoping’s famous quote about crossing the river by feeling one’s way across stone by stone (mo shitou guo he, which another panelist had invoked to suggest how China should move forward with financial sector innovation).
I said that while I still believed I could offer some useful comments on China’s capital markets, given current realities, a profound sense of humility, at the very least, is appropriate for a foreign analysts, especially an American one, who gives China advice about how to manage its financial system.
I concluded by identifying a few tools that Chinese regulators have besides monetary policy and fiscal stimulus packages (both of which they, like the US, have already deployed) to reach their goals with respect to capital markets, including the changes they’ve made with respect to the stamp tax (cutting it back to .1% after raising it to .3% during the bubble expansion) their pace of approving new funds; their ability to control the timing, size and pricing of IPOs and secondary offerings; their changes to the rules on the sale of illuqid shares (fei liutong gu) and their control over the exchanges. The basic point was that the CSRC has a wider range of tools than the US government for influencing markets.
This is the seventh year Wharton students have organized a China conference. This had to be a tough year to pull it off, given the ongoing global turbulence and retrenchment that probably made it hard to get speakers and sponsorships. But I was impressed with the logistics and content of the program and enjoyed participating.