The plunge in China's stock markets, which has sent shockwaves reverberating around the world, has amounted to a real-time stress test for the country. The bears, who have been predicting the Chinese economy's downfall, are now consumed with schadenfreude. The bulls hold that, no matter how violent the stock-market gyrations may be, China's economic success story remains intact. But, at this point, no outcome is certain.
It should be noted, first and foremost, that the current volatility, though not necessarily desirable, represents a natural market correction. Before dropping 30 percent from its June 12 peak of 5,166, the Shanghai Composite Index had climbed 150 percent over 12 months. An unprecedented intervention by the authorities — including allowing about 1,300 firms to suspend trading — stopped the slide, and the index closed on July 14 at 4,159.
Though the blame game is ongoing, the historian Charles Kindleberger's 1978 book Manias, Panics, and Crashes offers the perfect explanation for what China is experiencing. The economy has undergone a standard cycle of displacement, overtrading, monetary expansion, discredit, and revulsion, all in a matter of less than 12 months.
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