Seven Questions: The Wild, Wild East of Capitalism

LIU JIN/AFP/Getty ImagesSmokin: Its stock markets may dip, but the overheating in Chinas economy could last for some time.

FOREIGN POLICY: Is a stock market crash in China imminent, or has it already happened?

Andy Xie: The crash happened when the [Shanghai Composite] index dropped from 4300 to 3600. If the government had not intervened to prop up the market, it would have crashed to 3000. The government felt uncomfortable about this and all the government officials came out to support the index. The index bounced back up to about 4000, now its dropped to 3900 again. The market is now in a correction phase. About 300 stocks out of 1500 have dropped by roughly about 50 percent from the top. Most of those stocks are low quality. The index per se is down by about 10 percent, so its actually not much. But the real damage is much greater.

FP: Is it a full-blown correction?

AX: Well, I think were seeing a correction. By global standards its very severe, but by Chinese standards its not. Its a 50 percent downfall, 20 percent of stocks. By global standards, it would be horrific. But in China its not. Once you see stocks down another 50 percent, then you can call this a full blown correction.

FP: What impact has the drop in the market had on the Chinese public?

AX: Quite a lot. The market psychology is strange. I feel that this is a turning point. And because of this changing psychology, the market adjustment is probably going to last for quite a while. But this is not the final bust of the Chinese market, because money is still plentiful. The liquidity in the system is still humongous. Its not a general asset market meltdown. We have seen the stock market is not doing well, but the housing market is doing better and the liquidity is back in the property market and were seeing a [real estate] frenzy going on in second tier citiesChongqing and Shenzhen have gone through the roof. So China has still got a humongous amount of liquidity.

FP: Has much of the craziness stopped, or do you still see college students investing all of their tuition money in the market and the like?

AX: Its cooled off quite a lot. You see some tragedy going on: someone borrowed money, pawned his apartment to invest in so-called ST [special treatment] stocks, companies that basically are not able to report earnings, shell companies. These stocks are crashing right now, so a lot of people have been hurt very, very badly. But somehow Chinese people can take a lot. So you have tragedies from time to time, but so far we have not seen a lot of disturbances. The Chinese government has a way of dealing with these situations: They give you some money and so forth, try to make you feel better.

FP: Is it rational for a one-day decline in Shanghai to spill over into markets in New York and London?

AX: Yeah, in the sense that if the stock market declines it really affects Chinas economic outlook. China is now is a big part of global companies earnings. Look at Proctor and Gamble, Colgate, look at GMall thosefor so many companies, their earnings from China are not negligible anymore. So this is why the global stock market might have become connected to the Chinese stock market. But after dropping a few times, the global markets have learned to separate Chinas market volatility from its economy. Because the Chinese economy is still going strong, overheating. The banking system has tons of money, and the people who want to spend money have a lot of money in the banking system, and thats just a combination for overheating. Overheating in China will last for a while. The global financial markets have come to this view and therefore they disregard Chinas stock market volatility.

FP: Was Beijings decision to allow partial foreign ownership in banks real reform?

AX: On paper, the banks have done very well, with a lot of capital gains. But my worry is that their earnings are so dependent on government protection. Their lending margin is regulated by the government. The lending rates are regulated by the government. And the lending margin is just out-sized by global standards at close to 400 basis points. If there were genuine competition, I dont know if theyd do that well. And besides, the local governments are promoting local banks now, because the state banks, after they are listed on the stock market, may not work as well with the local governments as before. So I suspect the local banks will do much better than the state-owned banks.

FP: In 2005, you said that world oil prices were on the verge of collapse. Are you still bearish on oil?

AX: I did not say oil was on the verge of collapse, I said it was a huge bubblecrazy. At $400 billion, the financial capital in the oil market is a relatively small market. Chinese demand compared to this financial capital is relatively small. China imports 3.5 million barrels a day, total consumption is about 700 million barrels, and growth is about 7 to 8 percent. So were talking about growth of about 500,000 barrels a day. And 500,000 barrels at $50 is $25 million a day. When talking about China, thats what were talking about. But on the other side we have this $400 billion in the market, so what Ive been pointing out is this is a financial phenomenon, not a supply-demand [issue]. There is strong economic growth, there is strong demand, but this is not so important relative to financial demand. Financial demand will come down when the cost of capital goes up. When U.S. interest rates are high, then people will pull out. Its ridiculous; this is just a financial bubble. Now look at how many oil traders there are in the oil market today: five times as many as five years ago. The price of oil will come down when inflation is a problem and all the central banks raise interest rates. Thats what I see.

China-based economist Andy Xie is the former chief economist for Morgan Stanley in Asia.

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