A Chinese financial colony?

According to the greater fool theory, the price of anything is not set but relies on the expectations of market participants. Therefore, a bubble will last as long as there are people willing to pay more than the last buyer - in other words, bigger fools. That calculus can explain the frenzy of speculation that led to a record-breaking winning streak in Chinese stocks, which now looks like a big bubble.

There were extraordinary scenes across China this year as the ordinary masses were swept up in a collective stock frenzy. The park and plazas were empty of the usual armies of middle-aged women dancing in groups or doing tai chi. They were too involved in their new pastime, stock investment. People in their 20s and 30s are practically glued to their smartphones all day long to check on stock prices. Mainland shares doubled in value this year and the market sucked in over 100 million retail punters.

The extraordinary rally was actually carefully choreographed by the state and the Communist Party. China has become rich over a short period of time thanks to a high savings rate that supported investments. That was partly the reason why Beijing kept interest rates high. But at the same time, that elevated corporate and public debt. Total liabilities now hover around 230 percent of the gross domestic product.

The direction was dramatically reversed under President Xi Jinping. Premier Li Keqiang announced that the government will try to support economic growth in the 7 percent range and boost domestic consumption, a departure from higher growth based on industrial activity and exports. To boost local demand, people must save less and spend more. So the central bank cut the base interest rate four times over the last seven months and supplied ample liquidity to the market. The deposit rate in China now yields 2 percent.

The government then channeled money away from real estate into equities. Companies were advised to issue more shares rather than borrow money from banks. China has gotten a taste of debt-financed capitalism. Start-ups were encouraged to go public on the technology-specialized bourse in Shenzhen. Various regulations were eased to fuel stock buying. In April, individuals were allowed to open up as many as 20 accounts. Purchases of mainland stocks became easier for foreign investors. Authorities have done everything they can to engineer a stock binge.

But for the last two weeks, the main Shanghai bourse has been on a losing streak with the composite index falling by more than 20 percent. The bull has been transformed into a bear. There is hype about an epic bubble burst. Foreign investment banks like Goldman Sachs and JP Morgan said this year’s extraordinary stock run in China was not natural and that shares are irrationally overpriced considering the fundamentals of Chinese companies.

But despite the dangerous volatility and high risks in the Chinese market, it has unquestionably made big strides. Trade turnover for the main Shanghai bourse is double that of the stock exchange in New York, 30 times bigger than Seoul’s and 10 times bigger than Tokyo’s. The landscape of the world’s equity markets witnessed a sea of change due to the Chinese frenzy. Morgan Stanley is now deliberating whether to include the Shanghai index in its global index MSCI. Goldman Sachs established a headquarters entirely focused on Chinese shares. It merged the Seoul desk with Tokyo’s. JP Morgan is making a similar move.

The Seoul market is generally shunned. Korean MBAs can hardly find a job because investment bankers want to recruit young Chinese movers and shakers instead. Korea’s National Pension Fund is the world’s third largest institutional investor with funds worth 484 trillion won ($4,325 billion). It is courted by investment banks around the world. But global capital in search of investors skips Seoul and the National Pension Fund during Asian tours that include Tokyo, Shanghai, Hong Kong and Singapore. They will have one less reason to stop by Seoul when the National Pension Fund moves its headquarters to Jeonju, South Jeolla.

In modern history, a nation builds its power through industrial production, trade, the military - and then finance. China wants to make that happen in its quintessentially quick way. The Seoul market pales in comparison. With cash from the stock boom, Chinese funds are looking at Korean companies. They are gobbling up entertainment and gaming enterprises. Lim Ji-won, senior economist at JP Morgan, says the Chinese stock market could influence the Korean economy more than interest rate hikes in the U.S. Korea has long given up on its hope to build a financial hub. In fact, it could one day become a playing field for Chinese capital.

JoongAng Ilbo, June 30, Page 30

*The author is a senior editorial writer of the JoongAng Ilbo.

by Lee Chul-ho