China's stock market has been on a wild rollercoaster ride in recent weeks. More than $3 trillion in market value has been lost, and roughly half of China's 2,800 listed companies have suspended trading. Unfortunately, this extreme market volatility is also paired with sluggish economic growth. Last week, a key gauge of China's manufacturing activity tumbled to its lowest level in 77 months.
There are several drivers of this chaos. Over the past year, China's central bank had used the Chinese Securities Finance Corporation (CSFC) as a conduit to help Chinese people buy stocks with borrowed funds, helping to prop up stock market prices. Investors poured more and more into Chinese stocks, even though economic growth and company profits were weak. This effort had not stabilized the market as hoped, and recently the CSFC stopped injecting funds into the stock market. A classic bubble had developed, and burst.
And then there is the yuan (also called the Renminbi). Since 2009, rapid growth in the Chinese economy has pushed the value of the yuan up relative to the dollar. But then the slowing Chinese economy started to push the yuan downward. China's central bank intervened in foreign currency markets to maintain the yuan's value, but on August 11 it decided to let the currency drop by about 3 percent. This move may have been China's attempt to improve the credibility of its currency (the International Monetary Fund has been pressing the Chinese government to loosen its control over the exchange rate). For whatever its purpose, this devaluation should have, in theory, provided a boost to the Chinese economy by making Chinese exports more affordable to foreigners. And yet this wasn't enough to prevent further declines in the stock market.