Does this sound familiar? "Investors should be fully aware that there exists no stock on earth whose prices only surge and never slump." The China Securities Regulatory Commission, roughly equivalent to the British Financial Services Authority, posted this statement on its website in mid-May in a forlorn attempt to cool down overheating share prices in what is happily known as the "stir fry" (chao gu) stock market. The authorities' concern is easy to understand. China's stock markets are experiencing a classic speculative frenzy and may soon face the consequences: a crash, followed by bankruptcies, personal tragedies and financial dislocation which could damage the government and the Communist party.
On 9th May, the combined value of turnover on the two mainland China stock exchanges—Shanghai and Shenzhen—reached just under $50bn, more than the combined turnover of all the other markets in Asia, including Tokyo, and almost twice that of London. And this was but one moment of drama in a cautionary tale of modern China.
Since 2005, the Shanghai exchange's leading index has risen by 300 per cent. In the first week of May alone, the combined capital value of stocks quoted on both exchanges rose 5 per cent to 16.89 trillion yuan ($2,200bn). There are now more than 95m trading accounts held by individuals in China. The number of accounts has risen by 30 per cent in the past year, including 8.5m opened in the first quarter of 2007.
Stories abound of teachers selling their flats and grannies cashing in their life's savings all across China to speculate in the hope of instant riches. The Shanghai branch of the People's Bank of China reported in early May that 70bn yuan ($9.1bn) had been transferred from savings accounts to stock trading accounts in the first four months of the year. Just in April, savings deposits with Chinese banking institutions fell by 8.5bn yuan ($1.1bn).
These massive withdrawals point to the central cause of the speculative frenzy: China is swamped with cash that has nowhere to go. The long, breakneck economic boom has filled many Chinese pockets. Chinese typically save 40 per cent of their income, and some 80 per cent of their savings are hoarded in bank accounts with a total estimated value of the equivalent of $4,600bn. But deposit rates of 3 per cent are below the inflation rate, so holding so much cash is increasingly unattractive. Given the Chinese predilection for gambling, the stock market has proved an irresistible alternative.
More fundamentally, a chasm has opened up in China between the prosperity created by the economic boom and the country's rudimentary financial system. China's banks and other financial institutions offer few ways for citizens to invest their savings, the legacy of the old communist system which essentially saw banks as the means of channelling savings into supporting state enterprises.
The unresponsive nature of China's financial system has left the authorities in a bind. They were unable to control the last stock exchange boom and bust between 1999 and 2001, and they seem even weaker today. Investors appear convinced that the authorities do not want to burst the bubble before the 2008 Olympics in Beijing, and, as always, there are siren voices whispering that price to earnings ratios of 40 or more are not excessive, given the speed at which corporate earnings are rising (the FTSE 100 currently offers a ratio of around 13).
Basically, the authorities have four options: keep on trying to talk the market down; raise interest rates; impose a capital gains tax—which would be unpopular and hard to enforce; or allow Chinese to invest overseas. With characteristic caution, in May the authorities lifted some of the restrictions on overseas investment. Hong Kong's stock exchange promptly jumped sharply. But the permissible outflows are estimated at just $7bn-$9bn, not much of a safety valve. China could be heading for another speculative crash, on a suitably gargantuan scale.
Inflation returns
The official line is that the British inflation rate of around 3 per cent is only a blip. It was a bit awkward for all concerned in April when inflation reached 3.1 per cent, forcing Mervyn King, governor of the Bank of England, to pen a letter to Gordon Brown explaining why the target of 2 per cent had been exceeded by over a percentage point, but the embarrassment was expected to pass quickly. Will it? Despite the slight drop in May to 2.8 per cent, the view is slowly gaining ground in the City that inflation may be more resilient than the chancellor or the governor care to admit. One of the oddities of British official statistics is that they tend to underestimate the growth rate of the economy. If that has indeed happened, spending will have been higher than thought. And despite Gordon Brown's pledge ten years ago to raise Britain's trend rate of productivity, it has not kept pace with spending, so output will not be high enough to satisfy demand and prices will rise. The evidence from companies is that for the first time in many years, they feel they have greater flexibility to raise prices.
