Is the epicenter of the global stock markets shifting from Wall Street to Shanghai? For the third time this year, a sudden one-day plunge in the Shanghai and Shenzhen red-chip markets on May 30th, had global stock market operators holding their collective breath. Would Shanghai’s 6.5% plunge herald the bursting of a stock market bubble, and inflict big collateral damage to Asia’s economic locomotive? Speaking before the world’s top central bankers in Jackson Hole, Wyoming on August 25, 2006, Stanley Fischer, the governor of the Bank of Israel, and former managing director of the IMF, figured if the Chinese and American economies grew at 10% and 3% respectively over the next two decades, the Chinese economy would account for 18% of global GDP, and overtake the size of the US economy by 2030. India’s economy would equal half the size of the Chinese economy. China’s economy grew at an 11.1% annualized rate in Q’1, its fastest rate in more than a decade, as investment and exports powered ahead despite government curbs to keep the pace of the expansion in check. China has quickly grown-up to become the world’s fourth-largest economy at $2.4 trillion by expanding at double-digit rates for four years in a row. In contrast, the US economy was limping along at a 0.6% growth rate in the first quarter of 2007, it’s slowest in 4-years. At it’s current pace, China’s output could leapfrog Germany’s and catapult into third place in the global rankings as soon as 2008, lagging only behind Japan’s $4.5 trillion economy and the US’s $12.5 trillion economy. It overtook Britain in 2005.
The value of red-chip stocks in China have surged more than six-fold in the past two years to $2.4 trillion, equaling the size of its economy to become the world’s fifth-biggest equity market. The Shanghai and Shenzhen exchanges gained in size as local investors shifted out of bank deposits yielding zero percent, after adjusting for inflation, while Chinese company profits doubled in Q’1 from a year ago. But on May 23rd, Guru Alan Greenspan adopted a contrarian viewpoint, and predicted the boom in Chinese stocks could not last. “It is clearly unsustainable. There’s going to be a dramatic contraction at some point. In the last five years, the world as a whole is growing faster than at any time in the world’s history. It can’t last and it won’t last because it’s a one-shot adjustment. We will get major declines (in markets) from certain levels but it need not hurt employment or the real economy.” A big correction in Shanghai red-chips could wipe out Chinese personal wealth. The Chinese mainland’s two stock exchanges saw their market value surpass the country’s savings deposits for the first time in history on May 18th. Thus, a sharp plunge in the stock market, (if sustained for more than 24-hours), would spell big losses for Chinese households, shaking consumer confidence and spending. About 20.9 million accounts have been opened at brokerages so far this year, four times the amount in 2006, and brought the total number of stock trading accounts on the two bourses to 100-million, according to the China Securities Depository and Clearing Corp. Daily transaction volume on the Shanghai stock exchange mounted to a historical high at above 200 billion yuan.
So it was of great interest on May 29th, in a very unusual move, that China’s Ministry of Finance made a midnight announcement through the Xinhua news agency that it had decided to raise the tax on stock transaction to 0.3% from 0.1%, a move “intended to help promote the healthy development of the securities markets.” The Chinese tax hike follows warnings by regulators of stock trading risks and triggered a one-day 6.5% shakeout in Shanghai that wiped out $161 billion of market value. On May 18th, in its biggest effort to cap the market rally, China’s central bank announced a triple whammy, an interest rate hike, an increase in the bank reserve ratio and a widening of the yuan's trading band. When that effort failed to cap the stock market rally, Beijing tried a new psychological tack. In the Chinese stock market’s 16-year history, a tax on stock trades has always caused a market slump or snuffed out a bull run in stocks. In May 1997, Beijing raised the stamp duty to 0.5% from 0.3%, ending the bull-run and causing a bear market that lasted until mid-1999. Beijing lowered the tax in January 2005 to 0.1% to put a floor under the slumping market. Outside of China, traders couldn’t understand how a tiny 0.2% increase in the trading tax to just 0.3% could trigger a 10% plunge in Shanghai red-chips in a 24-hour period. Then again, psycho-analysis plays as big a role in trying to predict the mind of the Shanghai red-chip trader, as any particular piece of fundamental news. It’s the worry that Beijing might have more tricks up its sleeve to cool down the raging bull market for Chinese red-chips that causes the psyche of Shanghai traders to flip from extreme greed to extreme fear at a moment’s notice.
So far this year, the powerful Shanghai rally has been punctuated by four 24-hour panic sell-offs that were in retrospect, just better buying opportunities in a raging bull market. The imposition of a 0.3% tax on stock transactions triggered a 10% correction, but did not puncture the upward sloping trend-line at 3,900 that has supported a 60% surge in the Shanghai stock index this year. After briefly tumbling to an intra-day low of 3,853 on May 31st, Shanghai red-chips found strong handed buyers, who then decided to bid the market 8.4% higher over the next four hours to as high as 4,179, keeping the market’s long-term uptrend intact. Most likely, Beijing wants to see a flattening of the Shanghai and Shenzhen stock markets, and not the beginning of a bear market. “In my view, every market develops in twists and turns. The Chinese stock market is growing too rapidly. We hope it can grow at a steady manner,” said Chinese deputy central banker Wu Xialong on May 31st. “We believe that if the stock exchange in China cannot develop steadily, it will have an impact on the confidence of the economic development and have a psychological impact on the rest of the world.” Beijing could increase the tax on stock transactions again, if the market ignores its latest action, and continues to advance in a parabolic fashion to new all-time highs, or it could consider introducing a capital-gains tax. The last time China raised the stamp duty by 0.2% to 0.5% in May of 1997, it ended a bull run and triggered a 30% bear market slide that lasted until mid-1999. Yet the shakeout in Shanghai red-chips from tiny tax adjustments would be child’s play, compared to a possible sledge hammer coming from the US Congress in the form of 27% tariffs on Chinese exports to the USA. The rules of stock market trading do not necessarily follow the laws of Newtonian physics. What goes up doesn’t have to fall back down to Earth. Instead, markets can stay perched in the stratosphere, if central banks increase their money supplies at double digit rates, such as is occurring today, in 18 of the top-20 economies around the world. In Russia for instance, the M2 money supply is up 57% from a year ago.
In South Korea, the central bank is inflating the Korean M3 money supply at a 12.3% annualized rate, its fastest in 4-½ years. The Bank of Korea is anxious to prevent the won from rising too fast against the Japanese yen, and won’t lift its interest rates above its current level of 4.50% to slow the M3 growth rate, until the Bank of Japan takes the first move by lifting its overnight loan rate above 0.50%.
The Dow Jones Industrials (DJI) fell by 65-points in early trading on May 30th, in reaction to Shanghai’s 6.5% setback. But DJI traders figured that Shanghai red-chips would not fall below the key upward sloping trend-line at the 3,900 level, and wouldn’t begin a major bear slide anytime soon. By day’s end, DJI bulls reversed an early 68-point loss to a stunning 111-point gain to a new record high of 13,633. For the past five years, the Chinese and US economies accounted for 60% of the increase in world economic growth, which reached a record $35 trillion of output in 2006. So intuitively, it makes sense that the Shanghai red-chip and Wall Street blue-chip stock markets are the two most influential bellwethers in the world.
It’s not surprising that Australia’s Stock Exchange Index is closely tracking movements in Shanghai these days. Australia’s reliance on exports to China is the key driver in the country’s 16th straight year of economic expansion. China has surpassed Japan and the US to become Australia’s biggest trading partner. Two-way with the emerging superpower have soared over the past three years and in the year to March, and reached a combined total of $52.7 billion, eclipsing two-way trade with Japan of $50.6 billion. Australian exports to China in the 10 months ended April rose 28% from a year earlier. To answer the original question, with a vantage point from the Asian, European, and American time zones, it’s obvious that Wall Street still commands the greatest amount of respect among operators in global stock markets. But Shanghai is fast becoming the epicenter of the Asian sphere, and tremors from Asia are quickly transmitted to Europe, Latin America and North America. Beyond the mushrooming “yen carry” trade, perhaps the most fascinating story to unfold in 2007 is the strong possibility of a trade war between the United States and the emerging Chinese dragon, over the value of the yuan. Gary Dorsch © 2007 Gary Dorsch
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