China’s Stock Market Crash and Beijing’s Worst Impulses

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Now is the time for China to clarify that its stock prices will be determined by markets and let equity investors go to work. They will produce the information that the global economy needs most right now.
By Jennifer Carpenter and Robert Whitelaw
Think you need nerves of steel to invest in China’s stock market? Try regulating it.

The government promise of investor protection runs deep in China. To stand by and let the stock market seek its own level will take a strong stomach. In a country where markets are routinely managed and defaults are rare, investors may feel betrayed by the government’s lack of direct stock market intervention to mitigate the 15 percent drop this past Monday and Tuesday, especially after the propping up we saw last month. To let the market reveal new pessimism about China’s growth prospects will even further test the nerves of a government accustomed to managing information flow.

However, while this week’s monetary policy measures targeted at the broader economy may be warranted, direct stock market intervention causes more problems than it solves. If China’s regulators can stand their ground, this week’s turmoil will provide them with an opportunity to clarify their stock market regulatory stance, reduce distracting policy uncertainty, let China’s stock prices find their fundamental value, and continue on the promised reform path to more sustainable economic growth.

Stock markets are messy and the price discovery process can be roiled by exuberance on the upside and panic on the downside. But these same emotions are precisely what underlie the market’s ability to generate new information so effectively. Greed and fear drive investors to produce private information about potential gains and losses and buy and sell stocks accordingly. The clearing of these trades then aggregates this diffuse information into public signals to corporate managers and other investors, leading to more efficient corporate investment and capital allocation across firms.

Read full article as published in Foreign Policy

Jennifer Carpenter is an Associate Professor of Finance. Robert Whitelaw is the Edward C. Johnson 3D Professor of Entrepreneurial Finance.