Wu Xiaoqiu says he is more lost than ever on China's stock market
The senior economist delays his expectation of market maturity by 15 years, calls on China to appreciate the role of finance, and learns from Western modernization.
UBS, JP Morgan, and Nomura now predict the Chinese economy will miss Beijing’s official growth target of 5% by almost half a percentage. Even before China’s benchmark Shanghai Composite Index dipped below the crucial 2,800 points on Wednesday amid disappointing economic data and lackluster policy response, Wu Xiaoqiu, a senior economist, confessed that he was now lost than ever on the stock market of the world’s second-largest economy.
The respected former vice-president of the Renmin University of China (RUC) and dean of the university's National Academy of Financial Research lamented on August 24 in a public speech that there was no hint of a mature stock market with a new international financial center. He had to push backward his expectation by 15 years - from 2020 to, perhaps, 2035.
While insisting on confidence, Wu called for the rule of law, transparency, and respect for common sense and provided several concrete analyses and recommendations for overhauling the Shanghai and Shenzhen stock markets. Below is a translation of his speech in Beijing, based on the transcript published by the International Monetary Institute of RUC.
Today, I will mainly talk about the stock market. In the past two months, I haven't discussed much about how to reform the stock market, but instead focused on where the sources of China's economic growth lie, how to ensure sustainable growth, and the challenges facing China's economy. I've systematically addressed the value of finance in appropriate settings, which is mostly common sense. Sometimes, Chinese society strays from common sense. In fact, any country that respects common sense and laws will do quite well. Policies and institutional designs should respect human nature. We shouldn't see everyone as saints. We're all ordinary people who need to live and work, hope for continuous income growth, and seek to improve our living conditions. Society needs appropriate systems to ensure these goals can be achieved. System designs that align with human nature are responses to the needs of ordinary people. Noble moral goals are what we aspire to, but not everyone has to achieve them. Policy design should start from the needs of the ordinary people, not focus on lofty moral goals.
In the past two months, I’ve mainly discussed these issues and spoken some truths. Nowadays, speaking common sense is hard, and speaking the truth is even harder. As a university professor, I must tell the truth, to share what I think and know with society. But sometimes, being clear-headed makes one a bit worried, as certain policies, from the perspective of basic economic logic, are inappropriate. At times, all we can do is offer subtle and gentle reminders.
China's stock market is indeed rather confused right now. Even I, a scholar who has studied it for over 30 years, feel somewhat lost—I've never been as perplexed as I am today. Most of my life has been devoted to studying China’s stock market, and at times, I've also studied financial structure and function. Modern finance's foundation lies in the stock market. In the past, I was full of confidence. By 2010, I had hoped that by 2020, China’s stock market would be largely standardized, and I even thought a new international financial center would have been established. But now it’s 2024, and we’ve yet to see even a hint of that. The central government has said that by 2035, China will become a moderately developed country; perhaps by then, we may form the basic framework of a financial powerhouse.
What does the basic framework of a financial powerhouse entail?
First, the liberalization and internationalization of the Renminbi must be achieved. For a large country like China, the liberalization and internationalization of its currency is a fundamental feature of whether it has become a financial powerhouse. A country’s currency going global and having strong credit is the most important sign that the basic framework of a financial powerhouse has been established.
Second, the stock market or financial market must be open to the world, to such a degree that it becomes an international financial center. This international financial center would be a hub for trading RMB-denominated assets and wealth management, with a high proportion of foreign investment. Both China and the U.S. are large countries with certain similarities in economic and financial structures. From the perspective of building an international financial center, we cannot use Singapore or even the U.K. as benchmarks. Instead, U.S. finance should serve as a major reference point for China’s financial development. China's reforms needs to be based on national conditions and follow its own path, while also learning from the experiences and rational core of the U.S. financial market. These two aspects are not contradictory. We must not set up a dichotomy between China’s development path/model and harnessing the outstanding achievements of human civilization. Over the past 40 years, the success of China’s economic development lies in not pitting the socialist market economy with Chinese characteristics against the market economies of developed countries. China’s socialist market economy has extensively absorbed the rational core of modern market economies. While developed countries’ economic models differ, their commonalities are clearly the most important. This is a matter of methodology and thinking. In building a financial powerhouse, China must, of course, follow its own path. We cannot completely replicate the models of the U.S. or the U.K., but some important core principles are the same or highly similar, while we must also explore new approaches based on China’s national conditions. China’s path to modernization does not conflict with that of Western developed countries; they are two different models with the same core. China’s modernization must absorb the successful experiences of Western developed countries or modernized nations, reflecting common features such as highly developed economies, rule of law, reduced wealth disparities, low corruption, a good ecological environment, proper care for the elderly, education for the young, and access to healthcare—all hallmarks of modernized nations. Our thinking and methodology must be open and inclusive.
In terms of becoming a financial powerhouse, the openness of the stock market to the world, becoming a global financial center, and becoming a hub for RMB-denominated assets are clearly important vehicles for achieving this goal. I now push back the timeline for this goal to 2035, delaying it by 15 years from my original 2020 vision. Clearly, China still has a long way to go in achieving modernization.
The cornerstone of a financial powerhouse is the rule of law, the country's soft power, and its international credibility. It also requires a broad network of international relationships where partner countries themselves have strong credibility, and everyone trusts each other. For us, the process of establishing the rule of law is long and requires arduous effort.
China’s goal of becoming a financial powerhouse is a grand one, which requires us to continuously improve our legal system. Because only when investors have confidence will capital continuously flow in. The rule of law determines the flow of capital. Becoming a financial powerhouse is an essential part of China’s social modernization. The stock market in a financial powerhouse is clearly not just a financing market. A financing market without returns has no future; it will inevitably become a purely speculative market. For quite a long time, we did not understand the stock market’s important role in China’s modernization and in building a financial powerhouse. Correct understanding is the premise of success. Many things are done poorly because there’s a problem with understanding. Once understanding is correct, the market can prosper.
In modern society, the cornerstone of wealth management is the stock market—a transparent, liquid, and growing stock market. Liquidity is the important precondition for wealth management. If assets aren’t liquid, wealth management becomes difficult. Growth potential and liquidity complement each other.
I am very worried about the currently depressed market. The stock market is the core of the modern market economy. It requires society to have a high degree of transparency, a developed commercial civilization, a strong culture of honoring contractual obligations, and a widespread culture of trust. False accounting, lying, and disclosing false information are incompatible with the nature of the stock market. But in today’s society, lies are rampant, which conflicts with the essential traits of the stock market. The accounts, statements, and materials are often falsified. Local governments used to introduce many incentive policies, where companies would receive huge rewards for going public, so they found ways to cook the books. Sometimes, even accountants and auditors got involved, benefiting everyone in the chain. False disclosures and falsified accounting have even worked in tandem. The China Securities Regulatory Commission (CSRC) has struggled to take effective action against it.
China’s path to stock market reform is long, as it requires a developed commercial civilization and a strong social contract, along with sufficient transparency. Transparency is the lifeline of the stock market. Our reforms seem to need to start at the genetic level—they are difficult and complex and require long-term preparation in thinking. The direction of the registration-based system [for IPOs] reform is correct, but it must be based on strict laws. The reason false information disclosure and insider trading are rampant is that the penalties are not severe enough, and the cost of breaking the law is too low. We now must amend the laws and establish clear and harsh penalties for all violators, including the institutions and individuals in the chain. Current penalties are too lenient. In November 2001, when Enron’s financial fraud was exposed, the U.S. SEC imposed very harsh penalties. Enron was penalized and fined to the point of non-existence, and the fines were not confiscated by the Treasury but compensated small and medium-sized investors through class-action lawsuits, as they suffered heavy losses due to the false information disclosure. We cannot allow such penalties to go into the state treasury; they must compensate relevant small and medium-sized investors. This logic is clear. Otherwise, it is unfair to small and medium-sized investors, and they will lose confidence in the market. They will no longer invest in this market because their legitimate rights and interests are not protected. Investment carries risks, and risk must be borne by the investor, but the premise is that information disclosure must be true, and transparency is the prerequisite. In the process of developing the stock market, China must establish a compensation mechanism for small and medium-sized investors. Losses caused by false information disclosures that affect investment decisions must be compensated by the responsible parties. This is the basic legal guarantee and an important institutional arrangement to maintain market confidence.
The foundation of harsh penalties is the establishment of an investor compensation mechanism. The compensation mechanism is complex, involving the legal structure and litigation mechanism, requiring corresponding legal arrangements, such as the agent system and class-action lawsuits. These must all be established. The stock market is the core of modern finance because its legal system and institutional structure are very complex. The ultimate goal of this complex system and legal framework is to maintain investor confidence and protect their legitimate rights and interests. This is not just a slogan; it requires the protection of concrete legal provisions. It is concrete. In this regard, we are still quite rough. Harsh penalties are for violators, not for small and medium-sized investors who bought stocks of companies with false information disclosures and then bore the delisting consequences.
Overall, the institutional reforms of China’s stock market over some time have been relatively good, including the regulatory framework under the registration-based system for IPOs, major amendments to the shareholding reduction rules, improved transparency oversight, and increased penalties for violations. For a time, IPOs had tendencies toward angel investing, venture capital, or even ICU-like tendencies, under which the market could not possibly grow. Now, the reforms we are undertaking regarding IPOs are aimed at avoiding these tendencies. Those ideas were incorrect and failed to grasp the core essence of the stock market. The stock market is complex, and we need a deep understanding of modern finance, but our understanding is relatively backward. Why did I specifically discuss the value of finance at the forum hosted by Nankai University on July 27? It was to tell society that finance has great value in today’s China, yet society harbors certain misunderstandings about finance. These misunderstandings have extended to the understanding of the stock market. The stock market's downturn is closely related to these misunderstandings. We must return to a correct understanding.
We must deeply understand the significant implications of the reform on reducing shareholding in sotck markets. Many people have not fully grasped the profound significance of this reform, which has important constraints on the future suppression of high price-to-earnings ratio IPOs. In the future, major shareholders cannot sell their shares at a price lower than the IPO price, which is an inherent constraint. There are also constraints on net assets, dividend ratios, etc. Meanwhile, regulation over the responsibilities of "gatekeepers" in fraudulent listings have undergone significant reforms. These reforms are the foundational work for the development of the stock market. If the foundation is unstable, everything will collapse. Foundational work must be done well and solidly. The regulatory authorities are currently working hard on these foundational tasks. In this sense, the future of China’s stock market still has hope, because laying the foundation is a long and arduous process. Without these foundational reforms, the market will not have the potential for sustainable development. Therefore, we must emphasize the far-reaching significance of these foundational stock market reforms over the past period.
I generally agree with the broad direction of the stock market reforms, but I have two points to highlight:
First, the new ST (Special Treatment) system. I personally believe it has significant flaws. For instance, when major shareholders violate laws and regulations by misappropriating funds, the company enters the ST process. I do not think this is correct. This new ST regulation essentially condones the major shareholders’ illegal misappropriation of funds. Instead of penalizing major shareholders or recovering the misappropriated funds, the company is immediately put under ST. This is unfair and unreasonable. After the ST designation, the company’s stock price hits the lower limit every day, eventually falling below 1 yuan for 20 consecutive trading days, entering the delisting process. This essentially means that small and medium-sized investors bear the enormous losses caused by the major shareholders’ illegal misappropriation of funds. I believe that in such cases, all means—criminal, administrative, and civil—must be used to recover the misappropriated funds from major shareholders. Once recovered, the company would be a normal one again. Major shareholders who take the money and leave the company to delist suffer little to no loss, and this is why major shareholders are secretly happy when their companies delist in China. We absolutely must not tolerate this illegal behavior from major shareholders. Strict criminal and civil penalties must be established to ensure they cannot escape unpunished, and small and medium-sized investors must not bear the losses caused by their illegal activities.
Second, regarding the delisting system arrangement for companies that violate the law, there must be corresponding relief and compensation mechanisms. For companies that are delisted due to violations, a civil compensation mechanism must be established, and compensation funds should be deducted from the assets of major shareholders or actual controllers. They cannot simply walk away after delisting.
I approach the study of China’s stock market from the perspective of a scholar and the basic logic of economics, mainly focusing on reasoning and logic. We must view the future of China’s stock market correctly and have confidence in it. It seems that our investment logic has also been overturned. Nowadays, funds are flocking to high-dividend stocks, mainly bank stocks. China’s stock market is becoming a stock-as-bond market, or another type of bond market. This logic differs from that of promoting technological innovation and the development of high-tech enterprises. I don’t want China’s stock market to completely turn into a stock-as-bond market. The stock market has great functions—it can promote technological innovation, adjust the structure of listed companies, and play a huge incentive role. How did America’s "Seven Sisters" or "Seven Brothers" emerge? We must deeply understand that the development of the stock market and high-tech enterprises is a virtuous cycle. A market that focuses only on high dividends is not a strong and competitive market. Therefore, reshaping the investment logic of the stock market is crucial. This is also an important understanding for promoting the development of the stock market.
This concludes my speech. Thank you all!