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Controlling capital market boom without hurting economy

By Robert Blohm (China Daily)
Updated: 2007-05-23 10:57

China's unprecedented stock market boom reflects the hopes and dreams of ordinary Chinese who are voting with their savings on the progress of China's market economy. The danger is over enthusiasm begot by an undersupply of stocks if the market economy does not evolve fast enough.

This is a chapter in the story of China's booming financial or capital economy versus a "real" economy that may actually be near recession and effective deflation. That deflation is reflected in domestic prices, including wages, that are not increasing fast enough compared with still untapped huge productivity potential in the real economy. Improving productivity prevents wage and price increases from being inflationary.

The State has relied on the monetary policy tools of the People's Bank of China. The central bank has increased interest rates and banks' reserve deposits to control the capital economy boom. But these measures depress the underlying real economy whose growth is fundamental to mitigating the capital economy boom. This is the subject of a forthcoming book by economist Xiang Songzuo being published by Peking University Press.

The concern is that the inherent volatility in the capital economy risks hurting ordinary Chinese as investors. The effects would be far more damaging than job loss or job change resulting from increasing productivity in support of a real economy. This real economy is the only sustainable driver of a robust and stable stock market.

The government has other tools to address capital market booms, the most immediate of which is the supply of stocks and property. The booming stock market should result in the introduction of more shares by State-owned enterprises (SOEs) into the market, just as a booming real estate market requires more property.

While property release by the government prompted the new property law, the supply of stock released by the State depends on the pace of privatization.

The stock market boom is a call for SOEs to spend the proceeds received from their initial public offerings as soon as possible in the real economy. They need to spend on capital goods (often imported), software, training, research and development to become more efficient and competitive. Investors expect SOEs to drain that money from the stock market, depressing stock prices, not to support share prices by recycling the same money to purchase stock again.

China's stock market boom is just a magnified general reflection of the health of the US economy. China's stock market remains vulnerable to economic factors that China does not control (like US Federal Reserve policy).

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