Rodger Baker: Hello, I'm Rodger Baker. I'm joined by John Minnich, and we're going to talk a little bit about the Chinese stock market and some of the implications for the crisis that we see unfolding right now. So John, as we look at this particular stock market fall, we've seen the Chinese stock market go up and down in the past. It's had some pretty precipitous drops prior to this. And in many times it really had minimal impact on the Chinese economy. It is just not how financing worked in China. What are some of the differences that we're seeing now?
John Minnich: I think there are two key differences this time around. One is just the sheer scale of the boom. So in the past, the stock market, market capitalization of Chinese stock markets hovered somewhere around $1 trillion to $2 trillion. Now what we saw was the peak of the boom in June 12, China's stock market capitalization, all the markets across the country, was something in the area of $10 trillion to $11 trillion. That's more than double what they were just six months ago. So the scale of the boom, the amount of capital going into China's stock market has been truly extraordinary compared to what we have seen before. The second thing I think is somewhat different about this situation, although the full impact of it we'll have to wait to see, we'll have to wait to see the full effects of it, but the second key difference is that in the past, as you've said, most financing in China didn't involve the stock market really. The stock market was somewhere between gambling and the lottery and a means of saving, personal savings. People would put their personal savings into the market. But it wasn’t critical to financing, corporate financing in the Chinese economy. Almost all corporate finances came through the state-owned banks. That's been something that the government has been actively trying to move away from over the course of the last year, trying to reduce the amount, reduce corporate reliance, SOE's reliance on banks for financing. And the stock market in the last year has played a very critical role in filling that gap to some extent. So that $6 trillion of new capital that's entered into the stock market, most of it in the form of personal savings by the 90 million or 100 million so individual investors that are involved in the stock market. Now, most of that has gone into, has played a critical role in filling that gap that used to be filled primarily by credit from state-owned banks.
Rodger: So if we look at this, this is going to have a potentially large impact though on the way in which China works toward restructuring their economy. This is an economy that is supposed to be moving away from that sort of manufacturing and selling abroad to something that is more driven internally that advances into a more modern-style economy and that is, in some ways, more insular, more capable of existing inside China, rather than being at such, the mercy of international trade flows and international consumption and things like that. So creating a space for Chinese companies, particularly small companies, to gain financing, to be start-ups, to provide employment, to be places for the innovation of new ideas, which is something that China needs in this transition period, would seem to be very important. So the stock market, I think, may have a pretty tremendous role in this if that's where they've been going with it. How much of an impact, then, do you think this is going to have on the overall direction and strategy of the Chinese economy?
John: I think that the impact on the major state-owned enterprises, on the state sector, is going to be relatively limited because these are the companies that would be able to fairly easily, fairly cleanly return to the banks. They still exist primarily within the state sector. But then there is this other component of the economy that the government has been very conscious and active about cultivating. It is this idea of these start-ups, tech-centered start-ups, and these are kind of, I mean not only are they companies that in the near term are supposed to fill in the gap left over by the decline of the housing sector, the decline of heavy industry and these industries that used to be the backbone of the Chinese economy. So not only are these companies supposed be the ones filling in that gap, but they are also very much emblematic of the kind of economy that the Chinese government wants to cultivate long term. And I think that this also goes to the point of why we did see Chinese securities regulators step in today and actively stimulate and inject capital into small and medium cap stocks on the Shenzhen Exchange. And these are the stocks that are connected to tech companies, that are connected to Xiaomi, the kinds of companies that, as I said, this is what the government wants the economy to become. And this is also the sector of the economy that the old channels of financing, the big state-owned banks that are comparatively less capable of financing in an adequate way. And it goes into also just the fact that China, China doesn't have the same kind of infrastructure that we have, in the U.S. for instance, in terms of assessing risk, but also just providing basic information about a lot of these companies. And I think that, as with prior collapses in the market, this kind of reiterates or reinforces the point that China still has a long way to go to develop these deep and stable financial markets. It has a long way to got to get to the point where companies and investors are able to assess risk, where the markets are functioning, not solely as a form of gambling or lottery that individual investors play, but as a legitimate source of financing to a critical part of the Chinese economy.
Rodger: No, it's not comfortable for a country to have a financial collapse or a financial crisis or some of these things. But it's often good overall for the economy. Bad for certain individuals, good overall for the economy because it works to weed out the weak, weed out the inefficient. So at some point, I think what we have is a question of political will. Are the Chinese going to be able to adjust the way in which they make policies to help out certain sectors, help out certain parts of the economy, but at the same time allow certain things to fall apart?
John: Well, and I think this does get to the process that we have been watching with President Xi Jinping, his efforts to consolidate political power around himself, around the office of the president. I think that there is recognition that the kind of economy that China wants to become, the economy I was just describing, an economy that is productivity-centered, that is profitability-centered, that is market-oriented. This is an economy that is going to have to be able to embrace and withstand periodic and cyclical downturns that, as you said, these are the things that rejigger the productivity and profitability of an economy. And that's something that historically China has been unwilling to allow to happen. And that's why you've got so much dead weight in the economy. You've got so much wasted or capital misallocation, so much wasteful spending. And so I think that we are approaching a moment where there is a recognition in the government that we can't go back, can't go back to what it was before. But in order to be able to make that transition, you've got to ensure that the political structure is going to be stable enough and is able to exert the kind of control needed at the critical moment, both in terms of domestic security, but also in terms of regulation of the economy. So I think that this does go to Xi Jinping's establishment of small leading groups for economic policy-making with the National Security Council. These are mechanisms by which I think the central leadership is attempting to put itself in a place that it will be able to make those difficult decisions, those in some ways revolutionary changes to push China into the economic model that it needs to get to.
Rodger: Thank you John. We still have a lot to watch on this, not only on the economic side, but really on the political side as well.
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