China’s economy is huge. They are now the world’s second largest marketplace, at $8 trillion, about half the size of the US and 11% of the world. They’re a major player in trade, manufacturing, consumer goods, and large infrastructure projects. But their equity market is tiny. At $2 trillion, they’re 3% of the world’s equity markets—about the size of France. And their debt market is even smaller.
Why the disconnect? Why would a world-class economy have such a nascent capital market? Because if the Chinese currency is ever to become a reserve currency, they will have to have liquid capital markets where participants can add or draw from reserves whenever they wish.
Part of the reason is that as an export-oriented economy, the Chinese have been able to self-fund their own development. They have not needed external funding, and their history with foreign capital has been problematic. In addition, the government’s penchant for planning makes dependence on volatile markets seem risky.
But times are changing. China is introducing a number of retail and institutional financial products: mutual funds, ATMs, options, and online payments. A liberalized financial sector will allow the Chinese economy to move away from centralized credit controls to a more diversified system. It will also make booms and busts more likely.
China’s immense economy is still underdeveloped. Opening up their markets is the next step for them on the world stage. Investors should be ready.
Douglas R. Tengdin, CFA
Chief Investment Officer