International Herald Tribune
Communist capitalists
Tuesday, June 12, 2007

HONG KONG: Some of the reasons why the Chinese stock market continues to defy both gravity and the half-hearted efforts of the government to cool it are normal and obvious. But there is another reason that says a lot about a particularly Chinese situation: the relationship between Communist party power and wealth accumulation.

The normal ingredients are a combination of high household savings, low real interest rates and buoyant corporate profits. The nation is awash in cash, in part the domestic counterpart of its trillion dollars of foreign exchange reserves.

Add to this fuel the Chinese love of gambling and the novelty of stock markets, and one has the same combination of circumstances that created mega stock booms in Hong Kong in the early 1970s and in Taiwan in the late 1980s.

But China has an additional ingredient, one that partly explains why the government is ambivalent towards the boom, which has seen stock prices double in six months and price-earnings ratios reach the stratosphere.

For every speech by a mainland official urging caution and for every small dampening measure ranging from taxes on share transactions to increases in bank reserve requirement, there is a speech from another official suggesting that the market buoyancy simply reflects the strength of the economy and the promise of the future.

Of course there are officials who fear that a sudden market collapse could cause unrest among the millions of new small investors who have rushed to take part in this modern form of alchemy, aiming to turn low yielding bank deposits into quick returns on stocks. Although in other countries Chinese have ascribed their stock market losses to bad luck rather than bad government, there is just a chance that the mainland could be different.

The main reason is that the stock market has become the quickest way for officials themselves, as insiders, to get rich quick - and to do so legally.

Even the normally very discreet World Bank recently noted the losses to public coffers resulting from the underpricing of initial public offerings of Chinese shares.

Billions of yuan which might have been collected from the state's sale of shares and put to use improving health and education for the masses had, by implication, ended up in the pockets of those who got first crack at the undervalued shares.

Of course, every company listing on every exchange wants its shares to go to a premium when trading begins. China also had reason to want to spread acceptance of the stock market as a place for investment, as a proper location for household savings. It needs a popular market if it is to continue to sell down its stakes and gradually privatize the economy.

However, there is another reason why the China Securities Regulatory Commission, which oversees the markets, and officials in general, like to see underpricing: The people who mainly benefits are the insiders, the directors, managers, underwriters and other insiders who are favored with share allotments and, if necessary, provided with cheap loans with which to acquire stock.

The absolute loser is the public; the relative loser is the small investor who cannot get stock at the IPO and must buy at a higher price in the secondary market.

The way it works for dozens of relatively small mainland listings has been seen on a grand scale with listings of major mainland enterprises in Hong Kong.

In addition to well-placed mainlanders themselves, very large blocks of stock are first offered to local tycoons and their companies. These placements to anchor investors help ensure the success of the offering, even though the price has already been pitched at a level which is most likely to ensure success. The net result is that relatively few shares are available for the public. One consequence there is a massive oversubscription leading to a stampede for stock when trading begins.

Even though the anchor investors and some of the insiders may be locked in for a while, they are still in a position to make huge profits by virtue of their connections. The investment banks are also huge winners. The listing companies also benefit from interest earned on the oversubscriptions, which have run into billions of dollars. The losers again: the state and the small investors who couldn't get allotments and had to bid up stock in the secondary market.

The listing of mainland companies is in principle beneficial for the economy and corporate governance. But the way it happens is more reminiscent of the Russian version of privatization than of that practiced in established capitalist economies.

Tens of thousands of party officials and company managers are still waiting for their chance to make money from an IPO. So the leadership is nervous about any measure which might kill the goose laying golden eggs for officialdom.