Today we are fortunate to have a guest contribution written by Jeffrey Frankel, Harpel Professor of Capital Formation and Growth at Harvard University, and former Member of the Council of Economic Advisers, 1997-99.
The plunge of China’s stock market that has taken place since June has received a lot of attention. The commentary says that the Chinese authorities not only have taken a variety of measures to try to boost the market on the way down but also that they did the same during the huge run-up in stock prices between mid-2014 and mid-2015, when the Shanghai stock composite market index more than doubled. The finger-wagging implications are that the Chinese authorities, particularly the stock market regulator, have not learned how to let the market operate and that they had only themselves to blame for the bubble in the first place.
There is unquestionably a lot of truth to this overall story. But am I the only one to notice that the Chinese authorities repeatedly tightened margin requirements during the bubble, in January and April 2015? And that in fact the event which apparently in the end “pricked” the bubble was the June 12 announcement by the China Securities Regulatory Commission of plans to limit the amount brokerages can lend for stock trading?
It does seem pretty clear that the extraordinary run-up in stock market prices from June 2014 to June 2015 was indeed fueled by an excessive increase in margin borrowing over the same period. Reasons for the increase in margin borrowing include its original legalization in 2010-11, moves toward monetary easing by the People’s Bank of China since November 2014 (in response to slowing growth and inflation), and the eagerness of an increasing number of Chinese to take advantage of the ability to buy stocks on credit. Nevertheless, it appears that the stock market regulator responded by leaning in the opposite direction.
This is the sort of counter-cyclical macroprudential regulatory policy that we economists often call for, but do not often see in practice. (I survey some of the research in the 2015#2 issue of the NBER Reporter. For example a recent study by Federico, Végh, and Vuletin found that China and a majority of other developing countries also adjust bank reserve requirements counter-cyclically.)
Someone could criticize the Chinese increases in margin requirements earlier this year by saying either, on the one hand, that their effects on the stock market did not last long (January and April) or, on the other hand, that they caused the crash (June). But at least the moves were in the right direction, which is not a trivial point.
This post written by Jeffrey Frankel.