The Fall of the Shanghai Stock Exchange

The Fall of the Shanghai Stock Exchange

Bryan Taylor, Chief Economist, Global Financial Data

 

              What happened to the Shanghai Stock Exchange when the Communists took over China?

              After the Japanese were defeated in China, the civil war between the Communists and the Kuomintang resumed. Initially, the Kuomintang had more territory, a larger army and more weapons than the Communists, but the demoralized and undisciplined National Revolutionary Army of the Kuomintang proved to be no match for the People’s Liberation Army. The Chinese people were tired of the corruption and economic and political chaos of the Kuomintang and supported the Communists.  By 1947, the string of Communist military victories made it apparent that the Communists would defeat Chiang-Kai Chek and the Kuomintang, and it wasn’t a matter of if, but of when the Communists would be victorious. Beijing fell to the Communists in January 1949, Shanghai and Nanking in April 1949, and Canton (Guangdong) in October 1949.  On October 1, 1949, Mao Zedong declared the creation of the People’s Republic of China. 

              But what happened to the Shanghai Stock Exchange when the Communists took over the country? The conclusion by some is that investors just lost everything, but did they?  In fact, many of the Shanghai capitalists moved their capital and their businesses to Hong Kong and although the Communists closed all the stock exchanges in China by 1952, the Shanghai capitalists moved from Shanghai to Hong Kong where capitalism was reborn in a city-state that was championed by Milton Friedman.

Before the Pacific War

              The Japanese attacked Shanghai on August 13, 1937, and defeated the Chinese on November 26, 1937.  The Japanese seized all of Shanghai except for the Shanghai International Settlement and the Shanghai French Concession. The Shanghai Stock Exchange, which was in the Shanghai International Settlement continued to operate, but closed on December 5, 1941, when the Japanese took control of the International Settlement in Shanghai. The Japanese also took control of Hong Kong on December 7, closing the stock exchange in Hong Kong until 1946.

              Wenzhong Fan constructed indices for the Shanghai Stock Exchange between 1870 and 1940 using data from the North-China Herald, issues of which are available from the Internet Archive.[i]  The North-China Herald was both a daily and a weekly publication that reprinted the Shanghai Stock Exchange Weekly Share Report through November 14, 1941, courtesy of J. P. Bisset & Co. The North-China Herald also published The China Stock & Share Handbook between 1912 and the 1930s which provided information on shares traded in Shanghai, Hong Kong and Tientsin.  The newspaper printed cash prices for Buyers, Sellers and Last Sales as well as information on the amount of Authorized Capital, Issued Capital, Paid Up Value, Dividends, Shares Traded and Sales Reported. The last issue was published on November 19, 1941, which contains quotations for November 14, 1941. Prices for the Shanghai Stock Exchange were also printed in Le Journal de Shanghai, issues of which are available from Gallica.  December 5 was the last day of trading in Shanghai because the Japanese closed the Shanghai Stock Exchange, but what happened after 1941?

              The Shanghai Stock Exchange reopened in September 1944 and remained open until August 1945, when the Kuomintang closed the exchange. It reopened in September 1946 with just 20 stocks listed. The stock exchanges in Tianjin and Shanghai were closed once again in August 1948 so the Nationalist government could reform its monetary system. The Shanghai Stock Exchange resumed operation in March 1949, but was closed by the Communists in May 1949, not to reopen for forty years. The PRC reestablished the Tianjin Stock Exchange in 1949 and the Beijing Stock Exchange in 1950 with ten and six stocks listed respectively, but both stock exchanges were shut down in 1952 because the stock exchanges were too speculative for the Communists, and they contradicted Marxist economic principles.[ii]

              There are several sources which can be used to find out what happened after the Pacific War ended and China was no longer ruled by the Japanese.  The Shanghai Evening Post and Mercury, issues of which are available from the Internet Archive, was published in New York and it published prices for both the Shanghai Stock Exchange and the Manila Stock Exchange. The Newspaper was published in New York using radio reports from China.  This is why one of the prices for the Shanghai Stock Exchange was listed as “garbled.”  The China Mail was published in Hong Kong and enables us to keep track of the Hong Kong Stock Exchange on a daily basis after it reopened in 1946, but the best source for information about the Shanghai Stock Exchange after 1945 is the Far Eastern Economic Review, issues of which are available from the Internet Archive, which provided reports on the fall of the Shanghai and the fears that many people in Hong Kong had that the Communists might seize Hong Kong, which it never did.

              The Far Eastern Economic Review provided price quotes from the Shanghai Stock Exchange for ten “Chinese” shares and eight “British” shares through May 1947, but no Shanghai quotations were provided after that. Some of the “British” shares were also quoted in Hong Kong while the “Chinese” shares were exclusive to Shanghai. Quotes on six shares were provided by the Shanghai Evening Post and Mercury in 1946. Because China suffered from hyperinflation between 1946 and 1949, prices of shares in Shanghai skyrocketed while prices in Hong Kong remained relatively stable. Shanghai Dockyards shares were quoted at CN$172,000 in May 1947 in Shanghai, but HK$12 in Hong Kong.  Arbitrageurs kept track of the exchange rate and differences in prices to profit from differences between Shanghai and Hong Kong. Since Shanghai allowed a seven-day deferral, this enabled arbitrageurs to balance prices between Shanghai and Hong Kong.

              Two articles in the Far Eastern Economic Review report on events in the Shanghai Stock Exchange in 1948 and 1949. In “Shanghai Shares in Hongkong,” (FEER, December 22, 1948, p. 658), the author relates that substantial business was done in Hong Kong in three Chinese shares, Ewo Cotton Mills, Shanghai Lands and Shanghai Dockyards. Traders in Hong Kong arbitraged shares between Hong Kong and Shanghai. The interest in Shanghai shares led to trading in non-quoted stocks in Hong Kong, which included not only the rubber shares of Indonesia and Malaya, but Shanghai Loan, Shanghai Exploration, Shanghai Gas, Anglo-French Lands and Hongkew Wharves as well as Wheelocks, Yangtze Finance and Asia Navigation. Eventually, these securities listed in Hong Kong and their prices were quoted in the China Mail. Despite the attempts to dispose of these securities in Hong Kong, there needed to be an interest in them for the market to thrive.

              When the “Economic Reform” measures of the Kuomintang were announced on August 19, 1948, share trading was declared illegal and trading on the Share Market in Shanghai was shut down. This forced trading underground into black markets.  The main trading on the black market was in British companies, especially ones listed in Hong Kong. (FEER, February 23, 1949, pp. 231-232)

              Before the war there were two exchanges trading shares in Shanghai, the Shanghai Merchants’ Stock Exchange which was owned and operated by Chinese, and the Shanghai Stock Exchange which was organized by foreign businessmen. This is where the designation of “Chinese” and “British” shares came from. Both were closed after the Japanese took control of Shanghai in 1941, but a black market sprung up to trade shares. The Chinese Exchange was allowed to open in September 1944, and the Shanghai Securities Exchange was organized in May 1946. Share trading began on September 16, 1946.

Until the end of 1947, 245 brokers were authorized by the Ministries of Finance and Economic Affairs to trade shares. By the end of 1947, only 32 stocks were admitted for transaction.  Trading on the Shanghai exchange included 29,533 million shares. The capitalization of the Shanghai Exchange was CN$7.078 billion at the end of 1947, which at an exchange rate of CN$140,000 to the U.S. Dollar made the capitalization of the Shanghai Stock Exchange about US$50 million. The capitalization of the Shanghai exchange is illustrated in Figure 1. By contrast, the market capitalization of the Tokyo Exchange in 1947 was around US$425 million. This is a substantial decline from 1925 when the capitalization of the Shanghai Stock Exchange was about US$1.5 billion during the rubber rally. Initially, all deals on the Shanghai exchanges were cash only, but in November 1946, deferred dealing was introduced.

 

Figure 1.  Capitalization of the Shanghai Stock Exchange in USD, 1870 to 1947

              There was trading in about 30 Chinese stocks in Hong Kong in 1947 which were not listed on the Exchange. Considerable business was done in “foreign” stocks such as Ewo Cotton, Shanghai Dockyards, China Fibre, Shanghai Realty, Asia Navigation, Ewo Brewery, Chinese Metals and Wheelocks. The capital of these stocks in Shanghai was converted into Hong Kong Dollars so their quotations could be coordinated with quotations on the Hong Kong Exchange. This also eliminated the impact of the hyperinflation China was suffering. Although Shanghai had the only official exchange in China, trading also occurred in Tientsin, Hankow and Canton. The Tientsin Stock Exchange was established in February 1947 where 13 stocks were listed including Chi Hsin Cement, East Asia Development, and Tsi An Water Works.

              The collapse of the Chinese Yuan drove prices more than fundamentals.  Figure 2 illustrates the exchange rate between the Chinese Yuan and the US Dollar showing its continual decline between 1937 when the Pacific War began and August 19, 1948, when the Gold Yuan was introduced at a rate of 3 million Chinese Yuan equal to 1 Gold Yuan.  The US Dollar was equal to 4.05 Gold Yuan in August 1948, but the Gold Yuan quickly collapsed in value and fell to 425 million Gold Yuan to the U.S. Dollar by September 1949 when the Communists took over China.

Figure 2. Chinese Yuan per U.S. Dollar, 1937 to 1948

              The impact of the inflation in Shanghai can be seen in a comparison of the performance of Ewo Cotton Mills on the Hong Kong and Shanghai stock exchanges.  The two stocks are illustrated in Figure 3.  The red line shows the path of Ewo Cotton Mills in Shanghai and the black line shows the path of Ewo Cotton Mills in Hong Kong.  While the price of the stock in Hong Kong declined after 1940, the price of the stock in Shanghai increased dramatically as inflation drove the price upward. By May 1947, the price of Ewo Cotton Mills in Shanghai was CN$75,000 while the price in Hong Kong was HK$10.

Figure 3. Ewo Cotton Mills in Shanghai (red) and Hong Kong (black), 1937-1947

              As the Communists approached Shanghai, investors knew that it was only a matter of time before the Communists took over the city.  Shanghai investors moved their holdings out of Shanghai and into either foreign shares listed in London, New York, Tokyo or elsewhere, or into Hong Kong.  At first, there was a “wait and see” attitude among investors who hoped they could work with the Communists once they took over Shanghai and the rest of the country.  The Kuomintang had failed to provide a stable economic environment, and investors hoped that they could work with the Communists to get the economy working again. 

              The Communists quickly defeated the Kuomintang in Shanghai in April of 1949 and factories, especially linen factories, began operating once again. At first, Shanghai industrialists were relieved that the Communist takeover of Shanghai had been quick and peaceful with a minimum of destruction; however, because the Communist philosophy was antithetical to stock market capitalism, Shanghai industrialists began moving their operations to Hong Kong.  Chinese shares were listed in Hong Kong in 1948 and quoted in Hong Kong through November of 1950 as Hong Kong became a substitute for the Shanghai Stock Exchange which was closed in April 1949. The China Mail continued to quote around 80 stocks until October 1950 when the number of quoted stocks fell into the twenties. Chinese shares quickly lost their value.

              How would have investors in Shanghai have done while the Communists were taking control of China?  To answer this question, we took four of the “British” stocks that traded in both Shanghai and Hong Kong and created an index of their performance in Hong Kong.  The index was equally weighted and included three stocks beginning in April 1947, including Ewo Cotton Mills, Shanghai Dockyards and Shanghai Land Investment Co. and then we added Wheelock Co. in December 1948.  The index of these stocks is provided in Figure 4. At first, the index doubled in value, rising from 94.3 in July 1947 to 193.4 in May 1948, but it was downhill from there. By the time the Communists had taken over Shanghai in April 1949, the index lost two-thirds of its value, falling to 63.9.  After a brief rally in May 1949 when the takeover of Shanghai appeared to be peaceful, it was downhill from there.  The index fell to 30 by June 1950 when the Korean War began and declined to 22.7 by December 1953. By comparison, GFD’s Index of Hong Kong stocks declined from 38.8 in July 1947 to 37.3 in May 1948, fell to 32.2 in April 1949, but rose to 40.7 by December 1953 while the Shanghai stocks declined in value.

Figure 4. Four Shanghai Stocks in Hong Kong, 1947 to 1954

 

              The stockbrokers at Felix-Ellis calculated a daily stock market index of 12 leading stocks in Hong Kong which shows how the market reacted to the gradual defeat of the Kuomintang by the Communists. The index was calculated between January 1947 and November 1949 and published in the Far Eastern Economic Review. As Figure 5 shows, the index slid continually from September 1947 to the end of 1949. The Korean War began on June 25, 1950, and UN forces counterattacked on September 15, 1950. On October 19, 1950, The Chinese People’s Volunteer Army crossed into Korea, recapturing Seoul in January 1951, though the UN counter-offensive recaptured Seoul in March 1951. Share prices in Hong Kong continued to slide until December 1950 when they reached their bottom and began a rally that lasted for the rest of the decade.

 

 

Figure 5. Felix-Ellis Index of 12 Leading Hong Kong Stocks, 1947 to 1949

              Jardine Matheson had the largest investment in China of any British firm with 20,000 employees in 1949, but the company found it increasingly difficult to operate in Communist China, and by 1954, it had either closed or sold all of its operations in China at a substantial loss.  Many Shanghai industrialists moved their cotton mills from Shanghai to Hong Kong. Hong Kong graduated from being an entrepôt for China to being a manufacturing center for the world.

Conclusion

              So what happened to Chinese shares after the Pacific War ended in 1945? There was active trading in shares in Shanghai between 1937 when the Japanese seized Shanghai and December 1941 when the Japanese seized the International Settlements and Hong Kong and trading on both the Shanghai and Hong Kong Stock Exchanges was shut down. The Japanese, the Kuomintang and the Communists all tried to squeeze money out of the Shanghai capitalists and at best, each of them tolerated the existence of the Shanghai Stock Exchange as something they could exploit for their own benefit. None of them encouraged it.

              When the Shanghai Exchange closed, trading moved into black markets until share trading was allowed to continue on the Shanghai exchange.  However, inflation was the primary driver of stocks between 1937 and 1948.  As economic chaos engulfed Shanghai and the victory of the Communists over the Nationalists became inevitable in 1947, Shanghai investors began moving their capital out of Shanghai and into foreign shares in New York or London or to Hong Kong which remained safe from the Communist victory.  However, the four Shanghai shares we tracked underperformed the rest of the Hong Kong Stock Exchange, continuing to decline between 1950 and 1954 while Hong Kong stocks staged a rally. The Shanghai Stock Exchange died a slow death that began in 1941 and ended in 1949, but Shanghai industrialists found refuge in Hong Kong and, to the extent that they were able, moved their operations to Hong Kong which allowed free enterprise capitalism to reign in the following decades.

              The Shanghai Stock Exchange was founded on November 26, 1990, and began operating on December 19, 1990.  Chinese companies began listing their shares on the Hong Kong Stock Exchange, issuing “H” shares which now represent over 60 percent of the market capitalization of the Hong Kong Stock Exchange. On July 1, 1997, Hong Kong was handed over to China. The Hong Kong Stock Exchange should be seen as a continuation of share trading in China between 1949 and 1990.