In 1979, China transformed from planned economy to market economy, or, to put it plainly, from communist economy to capitalist economy. That drastic transformation created the kind of chaos even its creator, Deng Xiaoping, could not have foreseen. Among the numerous issues and problems, two were outstanding and calling for immediate policy and action, i.e., where to learn the new system and which government agency to be in charge of the change.
To find a country to learn capitalist system, the U.S. was the logical and obvious choice, but they chose Singapore and South Korea instead. The reasons were that these two countries were close-by and friendly, while the U.S. was far away and not so friendly. That was a major mistake and the results were costly. For instance, a measure foreign to any legitimate capital market was adopted, namely, Stock Purchase Certificate (Rengouquan).
Rengouquan was a form of lottery and the winner was entitled to purchase a certain number of shares of a certain stock new issue at the offering price, which normally resulted in a sizeable profit during the new issue boom in the early days. Local governments were selling Rengouquan as a new revenue source and investors were standing in long lines, sometimes overnight, to buy them. For a while, it seemed to be a happy medium for all parties concerned, but the honeymoon did not last long. When the new issue boom had ended, the chaos began, to such a degree that it almost destroyed the early stock “market”.
When I was invited in 1986 by the central government to help, it was obvious that they had recognized the mistake and turned to the U.S. for advice and assistance. One of my first moves was to call for the immediate abolition of the Rengouquan system and it was later abolished.
As to the question: “who is in charge?” it was more confusing, because of the duplicate functions and responsibilities of the central government agencies. There were at least four agencies having to do with the economic reform, namely, Ministry of Finance, Central Planning Commission, System Reform Commission, and People’s Bank of China. At that time, China Securities Regulatory Commission (CSRC) and China Banking Regulatory Commission (CBRC) were not in existence yet. All four agencies reported directly to the State Council (the Premier’s Office), and all wanted to be in charge.
People’s Bank of China (PBC), being the central bank, finally won the nod and was put in charge of the establishment of the capital markets in China. Therefore, I was invited to advise PBC with regard to the formation of China’s capital markets, mainly bond and equity markets.
When I arrived in China in the spring of 1986, some seven years after the Economic Reform had taken place, there was no organized market for any form of capital. “Companies” were issuing stocks without registration or permission and those “stocks” were traded in street corners in major cities. Government bonds were issued and sold to the working population on a compulsory basis without a secondary market to trade or to cash in. Government bond holders realistically wrote off the bonds as a worthless piece of paper.
My first advisory meeting with the PBC was to discuss the opening of a secondary market for government bonds. The importance and urgency of a trading market, I argued, was twofold. One was to enable the holders to cash in for emergency purposes, and the other was to encourage more purchases on a voluntary, instead of compulsory, basis. It took two years and the secondary market was finally opened in 1988, marking the very first securities market in China.
The organized bond market was followed by two organized equity markets, namely, Shanghai Stock Exchange and Shenzhen Stock Exchange, both of which were established in 1990. Prior to the opening of the equity market, there were arguments as to where the stock exchange(s) should be located. Almost all major cities, such as Beijing, Tianjin, Qingdao, Shenyang, Xiamen, etc. were aggressively seeking permission to have their own stock exchange, which was considered extremely profitable and would add to the local government revenues. My advice was totally against multiple stock exchanges, except for Shanghai and Shenzhen, the former for its status as the nation’s financial center and the latter for its proximity to Hong Kong, a global financial city.
Through the opening of the bond and equity markets, China entered a new era and was confronted with new challenges and new problems. On top of the list were state-owned enterprises (SOEs). One of the major changes of the economic reform was to cut off government financing for the SOEs, which would have to seek financing either from the government-own banks or from the immature equity market. Accustomed to government financing, SOEs were not in the habit of repaying bank loans and responding to shareholders, creating bad debts for the banks and complaints from the shareholders.
These were the early days of China’s capitalism.