The sharp decline in Chinese stocks and the policy response is important for global investors but not on the grounds commonly cited. It is unlikely to have a major impact on the Chinese economy. It is unlikely to be a key factor in the IMF's decision regarding the composition of the SDR basket.
China does not have an equity culture. Equities account for about 12% of Chinese household financial assets. It is lower than the major economies and compares with 58% in the US.
The precipitous decline in China's equity market is unlikely to significantly disrupt corporate capital rising. It is true that initial public offerings have been frozen, but raising capital in the equity market accounts for about 5% of total non-financial company finances in China. It accounts for 62% in the US.
This means that the volatility of Chinese stocks is unlikely to have a strong direct impact on consumer spending or the corporate sector as much as such a decline would impact the US and other high income countries. If this is true, it begs the question: Why did Chinese policy makers respond so aggressively?
To begin to thinking about the question, it is helpful to consider the function of the equity market. We suggest that there is some variance. For example, in the US the role of the stock market is to distribute ownership risks. In contrast, in Japan the traditional role was to solidify inter-company alliances. The same may said of some continental European markets.
The function of the Chinese equity market is different. It is to pool and recycle household savings back into the largely state-owned companies. Institutional investors (mutual funds, pension funds, insurance companies, broker/dealers and foreign investors) account for 56-57% of US and Japanese equity ownership but only 10% in China.
The government (and state-owned enterprises) dominate the Chinese stock market. Estimates place it near 85%. Foreign investors, which own 20% of US shares and 30% of Japan's shares, own 1% of China's A-shares. Chinese shares that trade in Hong Kong, Taiwan, and the US have fared considerably better than the A-shares that trade in Shanghai and Shenzhen.
