The Market Intervention China Needs

Investing for the long term.

Photographer: Fred Dufour/AFP/Getty Images

Having put their credibility on the line by propping up the stock market, Chinese officials may now think they have little choice but to keep pouring resources into equities: Fears that the government might ease up are what seem to have sparked the rout earlier this week.

If Chinese officials are going to continue with this support, however, then they also need to look for ways to minimize the long-term damage of their intervention -- by strengthening China's market infrastructure, not just share prices.

QuickTake China's Managed Markets

Other governments that have intervened to shore up their markets -- through quantitative easing, for example -- have found that unwinding those interventions takes years. Meddling should be confined to efforts that promote stability without undermining market dynamics. When the government armed the China Securities Finance Corp. with $483 billion in liquidity to bolster Chinese brokerages, for example, it was employing the kind of confidence-building strategy monetary authorities elsewhere have tried before.

One way to determine whether a line has been crossed is to look at the goal of the intervention. It's one thing to try to prevent an unruly sell-off; it's something else to try to drive up the market index to some unsustainable level.

More important, the government needs to avoid the kind of arbitrary and heavy-handed threats that instill fear and uncertainty among investors. In China, for instance, foreign investors comprise only an infinitesimal share of the market -- barely 3 percent. Trying to paint the downturn as a Western conspiracy, as some officials have done, is counterproductive. In fact, greater foreign participation would help reduce the wild, sentiment-driven fluctuations in share prices that have plagued Chinese markets.

Nor is it useful to encourage the police to investigate and arrest supposed short-sellers. If they're to return to the market, both local and foreign investors need to see clear rules in place, not vague threats.

Indeed, even as the government continues its support for stocks, officials should press ahead with reforms to strengthen regulations that will restore investor confidence. Beijing is already paying the price for not having set stricter rules for margin lending, for example, which might have prevented the dangerous levels of leverage that exist today. Authorities should also impose stronger accounting standards and develop more credible ratings agencies.

Finally, the government has to crack down on the kind of mischief that has led Chinese investors to pay more attention to companies' political connections than to their earnings. If leaders truly want to reduce the casino swings to which China's markets are prone, they need to give people something more solid to invest in.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.