Is China's stock market really crazier than America's?
Another day, another China-induced stock market drop.
At the start of this week, China's major stock indexes rung in the New Year by dropping 7 or 8 percent, inspiring sell-offs throughout Japan, Europe, and the United States. Then, a mere 13 minutes into trading on Thursday, China's CSI 300 index dropped 5 percent, setting off what has colloquially become known as "the circuit breaker." It's a policy the government introduced at the start of 2016 in response to the stock turmoil that hit midway through last year: If stock markets drop 5 percent, trading is halted for 15 minutes so everyone can calm down. If they drop 7 percent, trading stops for the day.
After the 15 minute pause on Thursday ended, it took all of one minute for stocks to fall past the 7 percent threshold, kicking off the full shutdown. A short while later, China's Securities Regulatory Commission announced it was suspending the circuit breaker and letting investors resume trading. "This is insane," one Chinese investor told Bloomberg. U.S. investors likely agreed, as America's major market indexes plummeted about 2 percent Thursday.
So how crazy was it?
One bit of mainstream wisdom here is that America's stock market is stable, mature, and integral to the functioning of the real economy, while China's is younger, unmoored, and more of a casino. If you're so inclined, you could certainly see this latest episode as a confirmation of that story.
For instance, "circuit breakers" like this can actually exacerbate the panics they're meant to cool down. Because participants know the chances of a shutdown increase as the market drops, more people will actually try to sell off faster to get out before the cutoff, thus accelerating the drop. That's especially true when the cutoff points are not spaced widely apart, as China's 5 and 7 percent thresholds obviously aren't.
More broadly, the Chinese government has thrown a slew of various measures and cash injections directly at the stock markets to get them to behave, rather than simply letting the markets do what they will while addressing the underlying causes of the turmoil.
That's the government's lack of sophistication in dealing with the market. But there's also the relation of the stock market to the rest of the country's private sector. While almost 50 percent of Americans hold at least some stocks, only 7 percent of China's urban population does. The country has been building a middle class as it's developed, and even encouraged it to participate in the stock market. But China remains far poorer and more unequal than America: Its middle class is a small buffer between a rich elite and a far larger population slice that's still desperately poor. Whatever America's own considerable troubles with economic injustice, its (shrinking) middle class remains a more robust "center of gravity" for the country's economic, social, and political forces.
Chinese corporations also rely on equity for a meager 5 percent of fund-raising, and the overall amount of Chinese currency parked in equities is among the lowest in the world. Add it all up, and China's stock market really does constitute a remarkably cloistered environment, largely a playpen for China's rarified wealthy, with few concrete relationships or feedback loops with the real economy.
So that's the mainstream story of the difference between America's stock market and China's. But here's the counterpoint.
Half of Americans may own stocks, but in many cases they're only tenuously connected to the financial markets. Less than 14 percent of Americans own any stock directly; the rest rely on managed funds and retirements accounts, like mutual funds, 401(k)s, and IRAs. Which is to say, the average joe isn't directly dabbling in the market. Rather it's young Wall Street functionaries managing many accounts for hefty fees who are doing the gambling. Is that fundamentally different from China's casino?
Another line you often hear is that the U.S. stock market has more professional, long-term investors managing big portfolios and looking for real value, while China has far more inexperienced, individual retail investors reacting to short-term swings based on instinct and panic. Which seems intuitive, but it's also an incredibly convenient story for the American financial elite to tell: "If only China had more smart, sophisticated, and sober people like us, their financial markets would function just fine!"
The Econ 101 justification for free markets is actually very anti-elitist: That the forces of self-interest and competition, when applied to large numbers of people trading goods and services, will produce a diffuse "crowd wisdom" that's much more stable and reliable than even the most sophisticated expert can provide. No one worries about sell-off panics in the shoe market, or suggests the plumbing market can only function stably while being overseen by a sophisticated aristocracy. Even America has its own version of China's "circuit breaker" — though the thresholds are spaced at a more sensible 7, 13 and 20 percent for the S&P 500, for instance.
Arguably, America is doing better than China because we built a prosperous society with a big middle class first, then layered modern financial markets on top of it. China, meanwhile, has gone in something close to the opposite order. And America has had stock markets in some form for much longer, so you'd expect it to have more institutional experience in how to handle them adroitly.
But the truth is, financial markets are just intrinsically weird: No one's buying and selling concrete goods and services, just abstract legal and contractual arrangements for moving money around. That's why panics are such a unique problem: Even under the best of circumstances, it's still basically a casino, with all the attendant pathologies that entails. Maybe putting up with those pathologies are worth the benefits, maybe not.
But success is more a question of adapting to those pathologies than anything else. Asking whether a particular country's stock market is "mature" or not is basically a bad question.