What Can We Learn From the Chinese Stock Market Crash?

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A continued commitment to the right set of reforms can put China firmly on the track to more efficient capital allocation through the stock market and sustainable growth.
By Jennifer Carpenter and Robert Whitelaw
Few people who give international markets even a cursory glance can have missed the recent meltdown in China’s stock market. Between June 12 and July 8, the Shanghai and Shenzhen indices were down 32 percent and 40 percent, respectively, generating headlines around the world. After the authorities took dramatic steps to halt the plunge, the markets stabilized, but then dropped a record 8.5 percent last Monday. It is not too early to start extracting some lessons from this meltdown — lessons that could serve China well going forward. If the country is still committed to making the stock market one of the important components of its new, more market-based capital allocation model, then the recent collapse, while painful, could yet prove extremely useful.

The well-worn saw that those who forget history are doomed to repeat it applies to stock market bubbles and crashes, too. China desperately needs to avoid a repeat of the past few months. Of equal or even greater importance, the heavy-handed government intervention in the market has generated widespread concerns about China’s commitment to financial reform more generally. To both allay these concerns and prevent another similar episode, Chinese regulators will have to make an even greater commitment to reforms and capital account liberalization.

To understand the need for this commitment, we need to appreciate the causes of the run-up and subsequent meltdown. In hindsight, there were two key issues: a narrow investor base subject to dramatic swings in sentiment and set of market regulations and structures that exacerbated the worst tendencies of these investors.

Read the 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.