Over the last month, the Chinese government has taken extreme measures to reverse the stock market‘s decline.
The decline in Shanghai was part of a broader Asian sell-off, with stocks in Japan, Taiwan, Hong Kong, South Korea and Australia all posting big losses.
China’s stock market had a debt-fueled boom, followed by a crash
Between June 2014 and June 2015, China’s Shanghai Composite index rose by 150 percent. A big reason for the stock market rally was that a lot of ordinary Chinese people began investing in the stock market for the first time. More than 40 million new stock accounts were opened between June 2014 and May 2015.
And many have been buying stocks with borrowed money. The Chinese government used to strictly limit this practice, but over the last five years the government gradually relaxed those regulations.
Earlier this year, the authorities became concerned that the stock market’s rise had become unsustainable. So they began to tighten limits on debt-financed stock market speculation. The stock market peaked in June and then began to fall quickly. That caused regulators to change their minds again. In early July, they made aggressive efforts to push stock prices back up.
Those efforts seemed to work for a few weeks, as the market rose and then stabilized. But now it seems that even July’s extraordinary actions — which included ordering companies to buy their own stock and banning some executives from selling — weren’t enough to prevent further declines.
The Chinese economy is struggling
No government likes to see its stock market crash, but the plunging Shanghai Composite will be particularly embarrassing for the Chinese authorities. Positive coverage from state-run media helps to fuel last year’s stock market boom, and last months’ decision to intervene in the stock market tied the government’s prestige even more tightly to the market’s performance.
The broader Chinese economy isn’t doing very well either. Official figures show the Chinese economy growing at a 7 percent rate in the second quarter. That’s slow by Chinese standards, and many Western economists suggest that the official figures overstate China’s growth.
Weak Chinese growth has exerted downward pressure on China’s currency. The Chinese central bank allowed the currency to fall by 3 percent earlier this month.
For the last two decades, China has benefitted from an export-oriented growth strategy. But exports can’t power China’s growth forever — world markets just aren’t big enough.
So China needs to transition to an economy that’s powered more by domestic consumption. And as Vox’s Max Fisher has written, the economic reforms required to facilitate that won’t be easy.