2008 Stock Markets and the Race to the Bottom: “Stuck” in China

Since late 2005, China’s two stock markets, in Shanghai (SSE) and Shenzhen (SZSE), have risen over 600% only to fall by close to 60% from a peak in late 2007. The race up and down is reflected in China’s macroeconomic indicators, but the real story lies with individuals investing in the market. In contrast to past studies of China’s stock markets, this paper argues that individual investors, and especially those investing less than 100,000 USD, are a critical part of the market. One postulate is that it is precisely these “micro” investors who, despite the general consensus that China’s stock markets are “policy markets”, keep the state from regulating the market. Put warrants, literally worthless paper in the days before the end of trading, continue to become sites for speculative trading. The 2007 stock market rose 97%, while the 2008 market has fallen over 50%: the non-tradable share reform, allowing large and small holders to trade previously non-tradable shares, is the current bane of the market. Yet the culprits in abnormal trading are not “individuals”, but the companies, often owned by local governments, that are the vanguard of China’s reform. This paper reviews these developments in detail, and suggests a potential new theory of China’s securities reform.