Manias and Meddlers: Secret Past of Chinese Stock Market

Manias and Meddlers: Secret Past of Chinese Stock Market

By JASON ZWEIG



This week, the People's Bank of China jolted stock markets around the world with a surprise interest-rate rise, and the leaders of China's Communist Party called for "accelerating the transformation of the nation's economic-development pattern." This drive to manage growth harks back to a declaration on April 22 that "of the many government functions, the most important is to facilitate commerce and help industries."


The odd thing is, the Chinese government made that statement on April 22, 1903.

Amid the almost irresistible excitement over China's explosive growth, it is important to understand that the Asian giant has run this exact race before—several times—and the results weren't pretty.

The growth in the Chinese economy is real, and I don't mean to sniff at it. But stocks require more than growth alone to be profitable; they also need good oversight by bureaucrats and corporate managers alike.

The chronicle of capital markets in China stretches back nearly 150 years, and it is nothing like the story of unstoppable progress that many American investors might expect.

Stocks began trading in Shanghai in the 1860s. The first "share mania" struck in 1871, when shipping stocks rose by as much as 70%. In 1882, there was another bubble, this time in mining stocks launched by provincial governments. From 1889 to 1891, Shanghai was gripped by a mania for real-estate development companies. In 1910 came a boom in rubber plantations.

Each time, officially sponsored banks flooded the market with cheap credit—much as their successors have done recently. Each time, investors were swept up with enthusiasm, and the boom ended up in an inevitable bust.

In 1920, National Geographic called China "the greatest undeveloped market in the world of today." The next year promoters floated a wave of commodity offerings; in Shanghai alone, more than 140 stock exchanges sprang up. By 1922, many of the stocks had gone bust and all but 12 of the new markets had disappeared.

Even toward the end of World War II, there were more than 100 initial public stock offerings annually in China, says Zhiwu Chen, a finance professor at Yale University.

Chinese leaders have long believed they could somehow both unleash and keep a tight rein on capitalism. History, at least until recently, has proved them wrong.

As far back as the 1870s, provincial governors set up companies, then hired merchants to run them according to the governors' wishes. Many of these firms flopped.

In 1949, right after it came to power, the Communist Party re-established the capital markets that had been disrupted by war. One stock exchange opened in 1949 in Tianjin, another in 1950 in Beijing. The new government closed down this experiment in 1952, says Prof. Chen.

The tension continues today. "Most Americans probably couldn't conceive of the Republican or Democratic party appointing the CEO of Exxon Mobil," says Cheah Cheng Hye, chairman of Value Partners, a Hong Kong investment firm that manages $7.4 billion, much of it in China. "But many of the CEOs in China are appointed by the Communist Party, and they are not necessarily equipped to be corporate captains." Managers in China are rapidly becoming more professional, Mr. Cheah says, but that change still has a long way to go.

David Herro, lead manager of Oakmark International, a $6.2 billion mutual fund, says he and his team have visited China twice a year for the past 20 years. How much does he have invested there? "Zero," he says. "The government is still trying to pick winners and losers, and they've done a fairly horrible job at it." Before he will invest, he adds, "we want lower prices, and we want better corporate governance."

Prof. Chen thinks that the global financial crisis led China's leaders to believe that the Western model of capitalism wasn't worth copying as closely as they had thought. "There was less government interference in Chinese businesses a century ago," he says, "than there is today." Until companies become more accountable to shareholders, Prof. Chen advises investing only in shares listed on major exchanges in New York or Hong Kong, which he calls "the cream of the crop."

According to data from Morningstar and TrimTabs Investment Research, some $507 million poured into China-related mutual funds and exchange-traded funds last month, after $4.5 billion of inflows in 2009. Investors chasing China's glorious future may have longer to wait, and a harder time getting there, than they might imagine.
— intelligentinvestor@wsj.com; twitter.com/jasonzweigwsj