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BOHANON & STYRING: Bureaucrats still manipulate China's economy

July 25, 2015

Economic AnalysisChina’s Shanghai stock market has been on a wild ride. After nearly doubling in the 12 months before June, the Shanghai index was down 30 percent in three weeks. Imagine riding the Dow up 18,000 points, then watching it slide 6,000 points virtually overnight!

There’s nothing per se wrong with these gyrations. Throughout history, assets often rise dramatically only to fall precipitously. From the tulip bulb mania in 1630s Holland to the 2008 U.S. housing bubble, the story is the same. An asset gets “hot”. Others notice and jump on the trend (faux sophisticates call this “momentum investing”). Prices rise even more. Investors who don’t want to miss out on the party bid prices up still further.

Finally, some people look around and notice that prices have gone up far beyond any connection to reality. And the music stops. Those who got in early and cashed out make a fortune. Those who got in late … well, just ask those crazed Dutchmen who hocked everything to buy one tulip bulb.

What’s interesting about Chinese stocks isn’t that an asset bubble happened. Bubbles happen. It’s how the Chinese government reacted. It should teach us that China is a long way from a market economy. “Eminently capable technocrats are in control.”

The Chinese central bank injected a large dose of liquidity to stabilize the banking system. That’s pretty standard fare for central banks. But the government went far, far beyond that. Those “eminently capable technocrats” flat out tried to rig the market. Trading was stopped for days on 70 percent of the Shanghai issues. Trading has still not resumed on many of those. Large investors were ordered not to sell. To further reduce the supply of stock, new issues were prohibited.

Twenty-one large brokers were given huge amounts on newly created yuan and told to buy stocks as long as the Shanghai index stays below 4,500 (currently about 4,000). Margin requirements were all but repealed and vast amounts of borrowed money flooded the market.

All of this should remind us that China is a mosaic of different “economies”—part subsistence agriculture, part controlled by the People’s Liberation Army, and only part more or less “capitalistic”. The State still calls far too many of the shots.

The irony is those “eminently capable technocrats” might have only succeeded in making things worse for Chinese stocks. After all, who wants to buy something where bureaucratic whim determines value?•

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Bohanon is a professor of economics at Ball State University. Styring is an economist and independent researcher. Both also blog at INforefront.com. Send comments to ibjedit@ibj.com.

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