China’s financial institutions are still weak: They lack well‐defined private property rights and the rule of law; they depend on government manipulation and are divorced from reality. Those weaknesses are evident as we watch the roller‐coaster ride that investors are taking on the Shanghai and Shenzhen exchanges.
After more than doubling from a year ago, markets reached a peak on June 12, then lost more than 30 percent of their value in a matter of weeks. That rapid tumble has led to significant government intervention to “stabilize markets”—that is, to place a floor under stock prices.
The People’s Bank of China quickly lowered benchmark interest rates, relaxed the reserve requirement for banks and injected liquidity into the market. Funds were extended to state‐owned brokerage firms through the China Securities Finance Corp. in order to mitigate margin selling, and government wealth funds were instructed to enter the market to shore up asset prices.
More recent measures include a six‐month ban on stock sales by major shareholders controlling 5 percent or more of a stock, the halting of trading on nearly 50 percent of tradable shares on the two major exchanges, the end of IPOs by private‐sector firms and the relaxation of collateral rules for margin lending.
Establishing government‐funded “market stabilization funds” and other devices to tame falling markets may be politically popular in the short run but can severely damage China’s future development as a global financial center. What China needs are free private markets based on limited government, responsibility and trust—not more central planning and control.