Two-way through train better for mainland investors, brokers
While the mainland side appears to have gained the most, two-way stocks flow is better for all
The through train is back on, and this time not filled with passengers on their way to financial ruin.
The Shanghai-Hong Kong Stock Connect scheme, due to begin in October, is a two-way stock trading programme designed to keep a good portion of the benefits on the mainland. Hong Kong stockbrokers are already griping that Shanghai will get the bulk of the glory and commissions.
Compare this with the previous, one-way, scheme, announced in 2007 when the mainland financial system was overheating amid huge capital inflows. Beijing needed a relief valve, and some bright spark came up with the idea of letting mainlanders funnel their savings into another jurisdiction's bubble: Hong Kong's.
It is not an easy thing to operate a fixed exchange rate regime. When capital inflows are greater than capital outflows, a central bank has to print new currency to meet demand, otherwise the exchange rate will rise.
In the mid-2000s, China was sitting on years of accumulated trade surpluses, exports were booming, and foreign direct investment and speculative capital inflows were heady.
The central bank was printing a mountain of fresh yuan to keep the currency from appreciating by too much; but this in turn led to soaring growth in the money supply.
Domestic financial conditions were extremely bubbly, and property prices were rising at a dangerously swift pace.
Clearly, the country needed outflows to offset the inflows. Policymakers first turned to companies, a myriad investment restrictions on which were lifted overnight.
Some giddily jumped on the new opportunities. Others were strong-armed into investing abroad, especially in areas of "strategic" national interest, like resources - setting them up for huge write-downs when the global commodities bubble burst in 2008.
Mainland firms were not the only schmucks. In 2006, Beijing announced the qualified domestic institutional investor scheme, to allow individuals a rare chance to legally buy overseas assets in approved markets. In 2007, it expanded the quota.
That year, the State Administration of Foreign Exchange announced the "through train", a scheme that would allow direct investing in Hong Kong's stock market.
Luckily for mainland investors, pandemonium broke out in the wake of the announcement, and the plan was postponed indefinitely.
If the through train scheme had gone through at that time, participants would have been buying into a bubble just ahead of the 2008 meltdown; of course, many mainland investors who illegally invested in Hong Kong, excited by the announcement of the plan, did get burned.
Flash forward to today, and it would seem Chinese policymakers are much more sensitive to the financial rights and opportunities of their citizens.
The yuan trades somewhat more freely, and the capital account is less restrictive than it was in 2007, with huge outbound leakage both officially and unofficially (just ask a real estate broker in London or Vancouver or, of course, Hong Kong).
Savers can get better interest rates on their deposits, because interest rates have been partially liberalised and a shadow banking system has been allowed to compete for deposits.
Ironically, the fact that mainland stock markets are trading at record low valuations is another sign of increased financial freedom. Investors used to pay astounding prices to own shares on the country's bourses because they had few other choices; their savings were trapped on the mainland, after all.
All this puts the revived through train scheme in a different perspective. By turning the scheme into a two-way street, Beijing may actually help domestic investors, rather than treat them like hapless instruments in the foreign exchange management system.
The new scheme also gives pork barrel business to mainland brokers, who will be placing both outgoing and incoming orders. Back in 2007, investors would have had to rely more on Hong Kong brokers.
This is not to say the deal is a bad one for Hong Kong. The original through train was ultimately a dead end. Better a two-way street than no traffic at all.