Greenspan's China-Stock `Correction' May Not Spread
By Simon Kennedy and Scott Lanman

May 30 (Bloomberg) -- Even if former Federal Reserve Chairman Alan Greenspan is right, the ``dramatic contraction'' he predicts for Chinese stocks isn't likely to infect the international economy.

That's the conclusion of a number of international economists and former government officials around the globe. They say China's economy shows little correlation with its stock market, and the fact that foreigners are mostly excluded from owning shares -- even Chinese participation is limited to less than 10 percent of the population -- means the effects of a bursting of the bubble would remain contained.

``This is a relatively small casino,'' said Edwin Truman, a former director of the Federal Reserve's international finance division and now a senior fellow at the Peterson Institute for International Economics in Washington. ``Even the implications for the Chinese economy should be minor.''

The CSI 300 Index, China's benchmark, today fell 6.8 percent, the most in three months, after the government tripled the stamp tax on stock trading to 0.3 percent from 0.1 percent.

Until today the index had more than doubled this year and its stocks traded at 48 times earnings, almost three times the multiple for those in the U.S. Dow Jones Industrial Average.

`Dramatic Contraction'

Greenspan's May 23 comment that Chinese stocks may undergo a ``dramatic contraction'' echoed a comment by Li Ka-shing, Asia's richest man, that the market ``must be a bubble.'' People's Bank of China Governor Zhou Xiaochuan expressed a similar concern two weeks earlier.

The biggest threat to growth at home and abroad might be psychological -- if a drop by stocks in the world's fastest growing economy prompts investors to retreat from risky assets, undermining markets elsewhere.

A burst bubble usually means trouble for a nation's broader economy, as it was in the U.S. when technology stocks tanked in 2000. History suggests that isn't true in China. Between 2001 and the end of 2005, the then-benchmark Shanghai Composite Index fell by half even as gross domestic product grew about 46 percent. And while the economy is the world's fourth largest, its market accounts for just 4 percent of global value.

``The Chinese stock market has only a tenuous connection with the underlying real economy,'' said Harvard University professor Kenneth Rogoff, a former chief economist at the International Monetary Fund.

Minimal Effect

China's limited domestic ownership means that if stocks do slump the effect on spending and the economy should be minimal, said Jonathan Anderson, chief Asia economist at UBS AG in Hong Kong.

Total stock holdings in China account for just 25 percent of domestic wealth, and in Asia only Indonesia has a smaller market capitalization than China's 60 percent of GDP.

``The tradable equity market is still a very small part of wealth holdings in China,'' said Anderson, another former IMF economist. ``Even a significant domestic equity-market correction would have little or no impact on the rest of the mainland economy.''

Relying on Earnings

Economists say another reason for confidence is that companies have fueled the economy's expansion mostly with earnings rather than using the booming equity market as a primary source of cash. Chinese companies last year earned combined profit of 1.88 trillion yuan, according to the statistics bureau, compared with total shares sales of 197 billion yuan.

Ownership of Chinese shares in other economies is limited. China has capped foreign investment at an aggregate $10 billion in the yuan-denominated ``A'' shares, less than the market value of about 700 U.S.-listed companies.

``The world economy is not particularly exposed to share ownership in China,'' said Julian Jessop, chief international economist at Capital Economics Ltd. in London.

That means the global economy will only suffer if China's economic expansion begins to ebb, which few see happening.

While the Paris-based Organization for Economic Cooperation and Development last week echoed concern about the level of China's stocks, it maintained its forecast for more than 10 percent economic expansion this year and next, citing it as a key reason for why the world economy will remain robust.

Staying Strong

``If the Chinese economy stays strong, a decline in its stock market isn't going to affect the rest of the world,'' said Alec Young, an international equity strategist at Standard & Poor's in New York.

Such views haven't stopped China's authorities from being concerned about the potential fallout of an equity-market slump on shareholders who include monks, maids and cooks.

Investors on May 28 opened 455,111 new accounts to trade mainland shares and mutual funds, bringing the tally to 100.3 million, the China Securities Depository & Clearing Corp. said on its Web site. More than 20 million accounts have been opened at brokerages so far this year, four times the amount in the whole of 2006, according to the clearing house.

The People's Bank of China last month noted that savings are being diverted by households and companies into stocks. The central bank's benchmark one-year deposit rate, a ceiling for deposit rates commercial banks can offer, is 3.06 percent, little more than the nation's 3 percent inflation rate.

Paulson Presses

U.S. Treasury Secretary Henry Paulson is pressing the Chinese government to broaden its market size, regulations and infrastructure so that if stocks do drop, they do so in an orderly fashion. Chinese Vice Premier Wu Yi last week agreed to raise the limit on foreign stock ownership to $30 billion after talks in Washington with Paulson.

``By any standard this is a bubble,'' said Nouriel Roubini, chairman of Roubini Global Economics LLC and a professor at New York University's Stern School of Business. ``It's a dangerous bubble and it could burst with significant economic and financial consequences.''

Perhaps the greatest worry for investors and central bankers elsewhere is what a downdraft in Chinese stocks might do to investor sentiment globally, said Stephen Cecchetti, a former New York Fed research director.

February Rout

On Feb. 27, a 9.2 percent slump in China's main index set off a five-day rout that wiped more than $3.3 trillion from the market value of equities worldwide. Another drop could send jitters through the world's markets and economies if investors become skittish about their riskier investments, such as those in emerging markets or the ones funded by money borrowed in low interest rate economies such as Japan.

``Most of us have thought that risk has been underpriced,'' said Cecchetti, who is now an economist at Brandeis University in Waltham, Massachusetts. ``So if there is a catalyst for the repricing of risk, then I think there would be some serious concern.''

Truman and Rogoff said they're skeptical of a direct link between the February drops in Chinese and global stocks, and other economists say Greenspan's predicted crash may not even happen. Individual investors shrugged off the warnings of a bubble, with the CSI 300 Index falling less than half a percentage point in the day after Greenspan sounded the alert.

``At the Fed, Greenspan would say we only know bubbles exist afterwards,'' said Jim O'Neill, chief economist at Goldman Sachs Group Inc. in London. ``Do we know if there's a bubble in China? I don't.''

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