China’s Political Interventions

TOKYO – In the last week or so, stock markets around the world have been hit by an upsurge in volatility, with large price swings confronting traders in New York, Tokyo, London, and beyond. And the entire global financial spasm has been largely blamed on a single culprit: China.

In a free economy, market mechanisms can produce stability or instability. An increase in the price of a tangible good would typically cause demand to fall, leading the market toward a new equilibrium. By contrast, an increase in the price of an asset like a stock raises expectations of a further increase, causing demand to rise, potentially to excessively high levels.

In a planned economy like China’s, where policymakers use various tools to influence asset prices, such instability could, in theory, be avoided; indeed, the Marxist view is that government intervention to stop crises is precisely why controlled economies are superior to their free-market counterparts. But, in practice, that does not seem to be the case.

So-called price-keeping operations by China’s monetary authorities (an approach tried in Japan in the early 1990s) are presumably the reason why the domestic stock market rose sharply over the last year, far beyond the levels warranted by the country’s economic fundamentals. The recent stock-market plunge suggests that investors have concluded that equity prices have become unsustainable.