Distinguished experts, ladies, and gentlemen:
First, I’d like to thank Deputy Governor Chen Yulu for the invitation to today’s forum, which is themed at “New Trend, New Challenges, New Driver: China’s Finance and the Global Economy and Financial China in a Changing World”. The title itself is exciting and enterprising, manifesting the new horizon, new stance, and new mission of the People’s Bank of China (PBoC) as the central bank of a great country.
The China Securities Regulatory Commission (CSRC) oversees both the industry and market of securities and futures sector. Among the 120 million investors in the Chinese stock market, 80 million are small and medium investors. It was after I took office as the Chairman of the CSRC when I realized that this is a job which needs help and assistance from others, if we want to develop the stock market. It is for the same reason that I had to come for such an important occasion. The global financial system is shrouded under great complexity, uncertainty, and instability. Economic globalization, in the meantime, exposes the whole system susceptible to the complications of financial risks across countries and sectors.
After the global financial crisis of 2008, the G20 summit pushed for rounds of financial reforms, which somewhat enhanced the soundness of economic and financial systems (such as banking and capital market) in major economies. However, these efforts in effect accelerated financial risks to spread across borders. China is currently driving economic structural adjustment and supply-side structural reform, at a time when it simultaneously deals with the slowdown in economic growth, makes difficult structural adjustment and absorbs the effect of previous economic stimulus policies. China is now in a time of the New Normal (economic growth rate shifting from high to mid-high, optimizing economic structure with focuses on the tertiary industry and consumption drivers, distributing economic benefits more evenly, transitioning from element- and investment-driven to innovation-driven). In this endeavor, the legacy of previous financial reforms can no longer meet the challenges in today’s world. Years’ of risks piled up in the economic and financial systems worth closer inspections. At the Central Economic Work Conference, greater importance has been attached to the mitigation of financial risks. Risk control is an eternal subject in financial industry and it is unfathomable as risks change constantly. History is always the best teacher. Recently, I read some books on the history of financial crisis and would like to share some thoughts with everyone here. Basically, I have two points to make.
Firstly, capital market stability is an important part of financial stability. There are many books on financial risks, among which Beautiful Bubbles is one of the most read. It is a classic collection of cases of financial risks in the early days, including the South Sea Bubble in the UK and the Mississippi Bubble in France. Compared with today, there was merely a financial system at that time, and the bubble could hardly undermine financial stability. When the bubble broke, it was the investors who bore the brunt. When talking about the capital market’s, or simply the stock market's systemic impact on the financial system, the Great Depression during 1929-1933 in the U.S. was the first one that came to my mind. Before 1929, the capitalization of the American stock market accounted for more than 80% of its GDP. The stock market crash exerted deadly blow to the economy of the U.S. and other relevant countries. After the crisis, the U.S. rebuilt its financial system by stipulating the well-known Glass-Steagall Act, the Securities Act and the Securities Exchange Act. The SEC was subsequently established and rules were made to set up a risk-based operation and supervision framework. Such measures ensured a relatively steady capital market in the US for half a century.
And then, the Black Monday took place in the US on October 21st, 1987. The Chinese financial market was not quite open yet. Most people just knew there was a big mess in the American capital market, but few understood how it might affect the economy, both domestically or internationally. That was because we did not have our own stock market in China, not to mention any interactions with the American financial system.
Around 2000/2001, the American stock market witnessed the dotcom bubble, in which stock prices of tech companies had a roller coaster ride. The countermeasures taken by the Fed gave us a very good reference. Whenever there was a tumultuous time in capital market, the Fed can always successfully capture the key factors and signals of monetary policy, such as when to move along and when to fight the tides, when to send price signals, and when to work on liquidity. They have rich methods and experiences. Mr. Joseph Tracy, the Executive Vice President of the NY Fed is here today, and he knows about it more than anyone here. I believe he has a lot of experience to share with us.
Looking at the US financial system after the Great Depression, we can see that the Fed's policies have played a stabilizing role in the US financial system during each crisis. Mr. Milton Friedman put forward some criticisms on the role of the Fed during the Great Depression of 1929-1933 in his book A Monetary History of the United States. He suggested that it was the Fed's tightening monetary policy that turned a financial depression into an economic recession. After the Black Monday crash of 1987, Chair Greenspan immediately stated that the Fed had prepared sufficient liquidity to support the needs of national economy and financial system. The Fed conducted open market operations and lowered short-term interest rate promptly. Meanwhile, the SEC also adopted necessary measures, which together rapidly curbed the crisis from spreading. When Long Term Capital Management L.P. (LTCM) fell into distress in 1998, the Fed, for the first time, gathered 14 Wall Street large financial institutions to draw up a rescue plan. Among these institutions, only Bear Stearns stood against it. Allegedly, it was when the Fed and Bear Stearns fell foul with each other. In fact, the other 13 financial companies were also reluctant to chip in. But LTCM’s imminent bankruptcy would drag them along. Today, some of 14 institutions are either merged or closed. For work reasons, I’ve long hoped to meet the CEOs who were at the meeting with the Fed, but never got the chance. Whenever I thought about it, I can’t help feeling “eternity is nowhere to be found between the heaven and the earth”. Nonetheless, the LTMC bailout led by the Fed in 1998 will be long remembered for its tactics and finesse, which not only saved the US capital market, but also save the US financial system.
Since the 2008 international financial crisis, the Fed and the US Treasury have been concentric counterparts in rescuing the US high-risk financial system in the roaring waves. Many of the methods, tools, and experience are of great value for us to reflect on.
Mr. Alan Greenspan had a well-known speech in 1996. He said that if the collapse of the financial asset bubble would not threaten the real economy or employment, the central bankers would not have to worry. But at the same time, they still should not underestimate the intricacy between the asset market and whole economy. Therefore, considerations of account changes in the balance sheet (especially asset price changes) needs to be part of the monetary policy as a whole. Mr. Ben Bernanke also believed that monetary policies could deal with asset prices bubble in two ways, either let it go or pierce it. But both poses extremity which better be avoided. Then, it requires that monetary policy be proactive, timely, and appropriate to maintain financial stability. Or what we call well-managed liquidity gates.
Undoubtedly, there are lessons in history. For example, in 1989, after the financial plight in Japan, the central bank's monetary policy went against the financial vulnerability and recessionary capital market for a long time, which was likely one of the important reasons for the prolonged economic recession in Japan. It’s worth our further studies.
Secondly, the sound operation of the capital market is an important basis for the effective transmission of monetary policy signals. Since the 1980s, disintermediation in the financial sector picked up momentum. Non-banking system represented by fund and other asset management companies embarked on fast track. The capital market grew unprecedentedly in its function to support corporate risk management. Monetary policy and its signals transmit through multiple complex channels other than traditional banks. In practice, the capital market is able to respond directly and swiftly to macroeconomic variables and monetary policy signals, as it houses the largest number of participants in high transparency. Price fluctuations, futures and spot markets transactions, and all other pro- and counter-operations will quickly manage and mitigate risks, where by capital is channeled to the most valuable fields. Monetary policy signals, such as interest rates, exchange rates, total liquidity, and other derivative tools, are transmitted through the capital market. Under normal circumstances, the capital market is the most sensitive to monetary policy signals.
Monetary policy signals transmit through the capital market via five channels. First is collateralization. With stock prices on the rise, companies enjoy higher valuation in itself and in their collaterals, enabling their financing capabilities and magnifying monetary policy’s support to the real economy. Second is Tobin’s Q theory. Rising stock price also increases return on unit investment. Replacement cost is reduced and companies are more willing to invest. Third is wealth effect. If the prices of stocks and other capital instruments go up, it also adds value to companies’ assets and households’ wealth, thus in turn driving investment and consumption. Fourth is economy of scale and competitive advantages achieved by M&A and reorganization, where companies are able to obtain funds from banks at lower costs and with more convenience. Fifth is innovation in capital market supporting technological innovation and industrial upgrading, providing more employment opportunities, enhancing economic competitiveness and stability as well as in the entire financial system.
Certainly, the capital market has its boundaries. When bubbles take form and expand, the capital market would be inertia to monetary policy signals, or even react adversely. Such effect resembles a black hole which sucks in all or partial sunlight. If that happens, the bubbles may have reached extremity and pose dreary threats. Therefore, both central banks and market regulators shall spare no effort to avert black hole effect where the capital market disables monetary policy signals.
The IMF conducted follow-up researches in OECD countries on their economic recovery after each financial crisis, a field where many scholars have dived in. There are results showing that economic vitality of a country (in particular the extent, speed, and sustainability of economic recovery after a crisis) is highly positively correlated with the development level of the country’s capital market. The US is the best example. The US capital market is the most developed and so is its capability to recover. After the 2008 global financial crisis, American economy recovered very quickly. The fundamental rules prevail notwithstanding the differences between China and the US, European countries, and Japan. Just as an old Chinese saying goes like, stones from other hills may serve to polish the jade. The lessons of other countries are valuable reference for us.
China has its own unique practices and advantages, and has accumulated rich experienced in maintaining financial stability. For instance, the revised Law on the People’s Bank of China (2003) provides for the PBoC a statutory mandate to prevent and mitigate financial risks, and safeguard financial stability. I had been serving for this sacred duty for over 10 years in the PBoC. Looking back, we can easily find such examples as the PBoC-led set-up of four asset management companies for bad loans, the joint-stock reform of state-owned banks, risk disposal and reorganization of securities companies, and the joint-moves by multiple government agencies to address the unusual fluctuations in the stock market in 2015. All of them are telling evidence for the visionary and systemic role of the PBoC. Therefore, China is second to no one in terms of experience in this area. Today, the global financial system is grappling with uncertainty, instability and complexity at the same time, we should continue our studies on the implications of monetary policies signals to capital markets, as well as the relations between the two.
To conclude, China has to speed up the development of capital markets under the environment of sound and neutral monetary policies. Firstly, there is a promising future for capital markets in the socialist market economy with Chinese characteristics. We must be confident, self-assured, and accountable for this. Secondly, stability of capital markets is a critical part of financial stability. The CSRC will support the PBoC to undertake the mandate on financial stability. Thirdly, capital markets are expected to react more sensitively and promptly to monetary policy signals than any time in the past. We should use this policy time window effectively to deepen reforms of capital markets, and to avail ourselves of the monetary policies to strengthen capital markets. For this purpose, the CSRC will continue to value and treasure the coordination mechanism for financial supervision led by the PBoC, as to sustain the sound development of China’s capital markets.
Wish the Annual Conference a full success. All the best to the guests, experts and colleagues present here. I am looking forward to your insights to energize our capital markets.