There is a reason to be fascinated by what is going on in China. That nation’s rapid growth is putting tremendous pressure on the world’s resources. This is driving up prices in many areas, from fertilizers and food, through energy and other commodities and on to downstream impacts on construction material costs even in North America.

Yesterday I looked at where China is achieving its greatest successes and questioned whether the economic good times have staying power. A number of key trends within China seem to indicate that, despite the possibility of some cyclical adjustments, the long-term outlook remains positive for continuing exceptional growth. However, it has to be clearly understood that China’s version of a “free market economy” is not the same as we understand that term. Chinese equities are a prime example.

In a list of areas where China is becoming “big”, three of the world’s six largest companies (by market capitalization) are Chinese. However, this is where things get a whole lot harder to read. The value of shares on the Shanghai stock market is vastly inflated. The Shanghai exchange is a stock exchange as we know it only on a surface level.

Chinese companies do issue shares through IPOs, but those shares do not carry the usual ownership rights. That’s because the Chinese government retains ownership and control. There are private shareholders, nevertheless, because of limited alternatives. Chinese citizens are not allowed to invest outside the country. Saving accounts are unappealing because interest rates are artificially low (well below the inflation rate) and real estate ownership comes with its own set of uncertainties as to legal rights.

Government owns the vast majority of shares in the largest firms and there is only a small float of publicly traded shares. These have moved way beyond price-earnings ratios that would be considered normal in North America. Short-selling, which is a means to release “steam” and dampen market swings, is not permitted. Acquisitions, which are a normal and healthy way for firms to evolve and grow successfully, must go through central planning and are often rejected.

Finally, there is no widespread dissemination of information about companies comparable to the comprehensive annual and quarterly financial reports that we are used to seeing. And finally, companies themselves own a lot of shares in other companies and their earnings are inflated by increases in such valuations. This is the kind of circular dependency that can lead to huge price bubbles and consequent collapses.

This story is mainly based on an article written by Thomas Easton, appearing in The Economist magazine’s special report entitled The World in 2008.

Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News.

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