Market rout offers valuable lessons in open economy

If a sports game is affected by a sudden downpour, it is the referee's job to announce a halt of the competition. If, and heaven forbid, there is a fire in a movie house, it is the projectionist's obligation to call for the firemen, and to help direct a quick evacuation.

In either case, business as usual is irresponsible.

By the same token, no one can really dispute that if the Chinese government sees the country's stock market as in a disastrous moment, it will have to react according to its own judgment and the feedback it collected.

And as it has, in the last couple of weeks, by imposing one policy after another to arrest a sell-off that wiped out up to one-third of the value of the A-share market from its peak and might cause an even larger setback of the economy that was already struggling in a difficult transition.

Now that the panic that the Shanghai and Shenzhen bourses went through two weeks ago seems to have calmed down, one has to admit that the intervention directed by the premier's office in Beijing has done its work fairly swiftly.

A restoration of rationality will help the country's stock market, which is only a little more than 20 years old and boasts perhaps the largest group of retail investors in the world, to continue growing in size and in opening up to international capital as well.

It can be expected that the intervention policies would be lifted one after another once suitable regulations are stipulated on the trading practices that were deemed excessive, and the market returns to its normal functioning.

It is because what the government can do is only limited. It can, with all its "policy weapons", put an abnormal trend to a stop and create a new trading environment－with a more effective regulatory regime in particular. But all the policies put together still can't replace the market and the millions of investors, large and small, doing business on an everyday basis.

It would be a mistake to imagine that the interventionist policies will stay for good. Many of them are of contingent nature and simply cannot stay.

Instead, what can, and indeed should, stay are the lessons that regulatory officials and investors can learn from the wild volatility since the early months of the year. Any market that rises too fast would be seen as a bubble suspect and invite attacks on its value. A stock market of massive small investors and small funds, and only a few companies with a clear market niche and core competence, has an even stronger tendency of this kind.

It would witness more often a quick rally followed only by a quick bust.

The regulatory regime of such a market, therefore, will have to demonstrate some unique characteristics. It will have to make sure that:

・ Highly leveraged investment, for both institutions and individuals, are subject to a stricter limit and perhaps more detailed rules.

・ Financial futures had better be cordoned off to small individual punters and welfare funds.

・ More investment instruments, which may diversify investors' interests and perhaps generate more direct support to the government-led key projects, are available, such as a large market of government and corporate bonds.

・ There is a powerful fund that, with access to the central treasury, can be used by the premier's office to interfere with the market in case of a critical situation－preferably with full authorization by the national legislature.

・ And the regulatory body is composed of people with both a good sense of responsibility and good experience in the domestic and international financial markets.

Viewed from this perspective, one can also say that the recent stock market rout lends to China an important opportunity of learning, and thereby preparing itself for running a more open economy.