January 14, 2016

U.S.-China Economic and Security Review Commission 1 

China’s Stock Market Meltdown Shakes the World, Again

Nargiza Salidjanova, Senior Policy Analyst, Economics and Trade

After the stock market turmoil last August,* Chinese regulators were hoping for a peaceful start to the year, 

preparing to wind down the ban on sales for big shareholders and launching a new mechanism (a circuit breaker) 

designed to prevent dramatic falls on par with those seen last year. The plan backfired. China’s Shanghai and 

Shenzhen stock markets crashed on January 4, the first day of trading, followed by another crash on January 7; in 

both cases, the circuit breaker halted trading. The combined rout erased more than $1 trillion of value.1 The 

government’s attempts to stem the meltdown only worsened the situation, confusing investors and raising fresh 

doubts over the ability of the Chinese government to manage a slowdown in the economy. They also exposed the 

contradiction inherent in the Chinese Communist Party (CCP) leadership trying to introduce market-oriented

policies for the broader economy while maintaining control over the composition and behavior of the Chinese stock 

markets—an approach that leads to greater volatility and moral hazard. 

What Happened?

On January 4, the first day of trading in 2016, the Shanghai and Shenzhen stock markets fell rapidly (see Figure 1), 

causing the new circuit breaker system to kick in and stop the trading for the day about 80 minutes earlier than 

scheduled.

2 The circuit breaker mechanism, developed in the wake of the stock market meltdown last year, was 

designed to prevent excess volatility, and involved an automated process: After a 5 percent move by the index (the 

benchmark CSI 300, which tracks the largest listed companies in Shanghai and Shenzhen), the trading would pause 

for 15 minutes; a 7 percent move would stop the trading completely for the rest of the day.

The exact causes of such sales runs are always difficult to pinpoint, since stock markets—China’s especially so—

are inherently driven by investor sentiment. In this case, however, there are several culprits:

 New data reflecting the poor health of China’s economy. Caixin’s † unofficial estimates of China’s 

manufacturing purchasing managers’ index (PMI) were weak for the tenth month in a row—48.2 in 

December, down from 48.6 in November—spurring fresh fears among investors. 3 A PMI below 50 

indicates a contraction. In contrast, the official manufacturing PMI showed a slight improvement—49.7 in 

December, up from 49.6 in November—but investors are watching the unofficial index more closely 

because unlike the official one, it tracks smaller companies whose performance is viewed as a better 

indicator of the health of the Chinese economy.

4

 Expiration of the selling ban. The ban on selling by major shareholders (i.e., investors holding at least 5 

percent of a listed stock), introduced during a period of market volatility in summer 2015, was scheduled 

to end on Friday, January 8. Fearing that big investors would start selling once the ban expired, many small 

investors rushed to get ahead of any sell-off. 

 

* For a discussion of the stock market collapse in August 2015, see Nargiza Salidjanova, “China’s Stock Market Collapse and Government’s 

Response,” U.S.-China Economic and Security Review Commission, July 13, 2015. http://1.usa.gov/1fCBn9a. 

† Caixin is China’s well-regarded media group dedicated to providing financial and business information. 
U.S.-China Economic and Security Review Commission 2 

 The new circuit breaker. The mechanism itself fueled panic among investors, who rushed to sell before it 

kicked in.

Figure 1: Shanghai Composite Index, May 2015–January 2016

Source: Shanghai Stock Exchange via CEIC database. 

The story repeated itself just two days later on January 7, when trading on the Shanghai Stock Exchange was shut 

down for the day only 30 minutes after opening, resulting in the shortest day in the stock market’s history.

5 The 

slide was triggered when the People’s Bank of China (PBOC), the central bank, set the daily renminbi (RMB)

reference exchange rate*against the U.S. dollar 0.5 percent lower (see Figure 2), which investors interpreted as a 

sign the government was concerned about the weak state of China’s economy.

6

 

* The PBOC manages the value of the RMB by setting a new value for the RMB-dollar exchange rate each trading day, even while permitting 

fluctuations in intra-day trading within a 2 percent trading band. In August 2015, in order to allow more flexibility in the exchange rate and 

to counter expectations of a persistent appreciation of the RMB, the PBOC announced it will set the RMB daily trading rate according to the 

market-determined closing price within its trading band from the previous day. The PBOC continues to intervene heavily in the foreign 

exchange markets, however, selling dollars and buying the RMB to keep the latter from depreciating too quickly. For more, see U.S.-China 

Economic and Security Review Commission, 2015 Annual Report to Congress, November 2015, 50–52. http://1.usa.gov/1PIucJk. 
U.S.-China Economic and Security Review Commission 3 

Figure 2: RMB to U.S. Dollar Exchange Rate, June 2015–January 2016*

Note: The vertical axis is inverted to show RMB depreciation.

Source: Oanda. 

Just as it did in the summer of 2015, the government chose to intervene and attempted to stabilize the stock 

markets through the following measures:

 State-ordered purchasing. The “national team” comprising the China Securities Regulatory Commission 

(CSRC) and state-owned brokerages resumed share purchases, undermining the pledge to allow market 

forces to play a deciding role.

7

 Cash injection. The PBOC channeled RMB 130 billion ($20 billion) in short-term funds into the financial 

system to support the currency and calm investors.8

 Currency strengthened. On January 8, the PBOC tried to stop RMB depreciation, setting the reference rate 

higher.9

 Ban on big share sales extended. Under new rules announced by the CSRC, for the next three months, large 

shareholders will not be permitted to sell more than one percent of their stake, and must provide 15 days’ 

notice before doing so.10

 Circuit breaker suspended. Rather than calm tensions, the circuit breaker escalated the panic, as people 

rushed to sell before the stocks went down enough to trigger the trading halt. Realizing the circuit breaker 

was doing more harm than good, the CSRC announced it was suspending the mechanism on January 7—

four days after initiating it.11

 

 

* For discussion of RMB’s inclusion in the SDR basket, see U.S.-China Economic and Security Review Commission, Economics and Trade 

Bulletin, December 4, 2015. http://1.usa.gov/1Zq8D85; for information about the new multicurrency index for the RMB see U.S.-China 

Economic and Security Review Commission, Economics and Trade Bulletin, January 6, 2016. http://1.usa.gov/1OZ8HqF. 
U.S.-China Economic and Security Review Commission 4 

Implications

The panicked response of Chinese investors masks the fact that China’s stock markets remain a very small part of 

the country’s economy, and have limited bearing on its overall health.12 The Shanghai Stock Exchange in particular 

is dominated by state-owned enterprises and heavy industries—all ailing sectors that do not represent the most 

productive segments of the economy.

13 Yet, the factors informing investor behavior and the government’s attempts 

to interfere and control market outcomes speak a great deal about the problematic way in which the government 

approaches economic policy.

In 2013, the Chinese government pledged it would allow the “market to play a decisive role” in all aspects of the 

economy,

* but when it comes to some sectors of the economy, the financial sector among them, Beijing’s view 

appears to be that the market can play a role as long as it does what Beijing wants it to do. The Chinese government 

places a great emphasis on maintaining stability, so the impulse to control the stock market stems from a desire to 

head off any possible unrest or criticism of the CCP. China’s government has a poor record of managing the stock 

markets. Policies pursued by the government in search of new sources of growth are at least partly to blame for the 

creation of the bubble that burst in the summer of 2015. Investment in the stock market was viewed as a way to 

generate capital for SOEs, to boost funding for private companies, and to provide households with a means of 

realizing returns. Official media outlets, including People’s Daily, ran laudatory editorials describing the stock 

market growth as a sign of economic strength.14

By once again intervening and reasserting control, the government is raising expectations that the “national team” 

will be called in any time there is volatility. In addition to firmly entrenching moral hazard as a major byproduct of 

Chinese government’s policymaking, this kind of intervention is expensive. The government spent billions on futile 

attempts to stabilize the stock markets in the summer of 2015 and again in January 2016.15 Efforts to manage the 

value of the currency—which so rattled the stock markets this time around—are likewise pricy. Following the 

transition in August 2015 to the new exchange rate setting mechanism, the PBOC permitted the RMB to weaken, 

though it continued to intervene heavily in the foreign exchange markets to manage the decline very slowly. As of 

the end of December 2015, China’s foreign reserves slumped a record $107.9 billion from the previous month,

reducing the overall total of reserves to $3.33 trillion. For the full year, reserves fell $512.7 billion—another 

record.16 Most of the drop can be attributed to the PBOC’s efforts to support the RMB’s value.

The direct impact of this latest meltdown on foreign investors may turn out to be limited, but sentiment matters—

especially in stock markets. World markets responded to the meltdown in China with some volatility of their own. 

More than $2 trillion of value was erased from global stock markets in the first trading week of the year.17 As of 

January 13, though, Asian markets mostly traded higher.18 However, there is a danger of spillover into the real 

economy, with emerging markets most likely to be affected. A weaker RMB would boost Chinese exports, but also 

raises fear among investors that the weakness is a symptom of bigger structural problems in China’s economy. As 

the latest stock market rout demonstrates, such perceptions can lead to harmful economic consequences. The weaker 

RMB also risks sparking beggar-thy-neighbor devaluations across Asia.19

U.S. equity markets have not been immune to the panic spreading from China. On January 7, the Dow Jones 

Industrial Average fell nearly 2.3 percent, while the S&P 500 dropped 2.4 percent.

20 U.S. stocks showed some 

volatility in the following days, going into a steep sell-off on January 13, but rallying the next day.

21 Market 

sentiment aside, the Chinese government’s response (including lack of coordination, conflicting policy initiatives, 

and poor communication) presents a more long-term challenge, raising questions about the government’s 

commitment to economic reform and its ability to execute it. 

 

* For more on President Xi Jinping’s economic reform priorities and pledges (the Third Plenum reforms), see Nargiza Salidjanova and Iacob 

Koch-Weser, “Third Plenum Economic Reform Proposals: A Scorecard,” U.S.-China Economic and Security Review Commission, November 

19, 2013. http://1.usa.gov/1nfpyt0. 
U.S.-China Economic and Security Review Commission 5 

Disclaimer: The U.S.-China Economic and Security Review Commission was created by Congress to report on the national 

security implications of the bilateral trade and economic relationship between the United States and the People’s Republic of 

China. For more information, visit www.uscc.gov or join the Commission on Facebook.

This report is the product of professional research performed by the staff of the U.S.-China Economic and Security Review 

Commission, and was prepared at the request of the Commission to supports its deliberations. Posting of the report to the 

Commission’s website is intended to promote greater public understanding of the issues addressed by the Commission in its 

ongoing assessment of U.S.-China economic relations and their implications for U.S. security, as mandated by Public Law 106-

398 and Public Law 109-7. However, it does not necessarily imply an endorsement by the Commission, any individual 

Commissioner, or the Commission’s other professional staff, of the views or conclusions expressed in this staff research report.

Endnotes

1 Bloomberg, “China State Funds Said to Buy More Shares after Market Rout,” January 7, 2016. 

http://www.bloomberg.com/news/articles/2016-01-08/china-state-funds-said-to-buy-more-shares-after-1-trillion-rout. 

2 Yifan Xie and Shen Hong, “Circuit Breaker: China Calls Time on Stock Market Fall,” China Realtime (Wall Street Journal blog), January 

4, 2016. http://blogs.wsj.com/chinarealtime/2016/01/04/circuit-breaker-china-calls-time-on-stock-market-fall/. 

3 Leslie Shaffer, “Weak Caixin PMI Revives China Slowdown Fears,” CNBC, January 3, 2016. http://www.cnbc.com/2016/01/03/caixinpmi-falls-to-482-in-december-below-expectations.html. 

4 Leslie Shaffer, “Weak Caixin PMI Revives China Slowdown Fears,” CNBC, January 3, 2016. http://www.cnbc.com/2016/01/03/caixinpmi-falls-to-482-in-december-below-expectations.html. 

5 Shen Hong, “China Stocks: Trading Called off for Second Time This Week,” Wall Street Journal, January 7, 2015. 

http://www.wsj.com/articles/china-stocks-trading-called-off-for-second-time-this-week-1452133928. 

6 Lu Jianxin and Patrick Graham, “China Lets Yuan Slide, Starts Fight to Halt Turbulence,” Reuters, January 7, 2016. 

http://www.reuters.com/article/us-china-yuan-midpoint-idUSKBN0UL07Z20160107. 

7 Bloomberg, “China State Funds Said to Buy More Shares after Market Rout,” January 7, 2016. 

http://www.bloomberg.com/news/articles/2016-01-08/china-state-funds-said-to-buy-more-shares-after-1-trillion-rout. 

8 Bloomberg, “PBOC Injects Most Cash since September in Open-Market Operations,” January 4, 2016. 

http://www.bloomberg.com/news/articles/2016-01-05/pboc-resumes-reverse-repos-to-inject-130-billion-yuan-traders. 

9 Mehreen Khan, Chris Graham, and Tara Cunningham, “Markets Stabilize after China Strengthens Currency and Circuit Breaker Is Axed,” 

Telegraph (UK), January 8, 2016. http://www.telegraph.co.uk/finance/markets/12086208/China-stock-market-shares-plunge-ftse-100-

europe-live.html. 

10 Aaron Back, “China’s Shortest Day Will Prolong the Pain,” Wall Street Journal, January 7, 2016. http://www.wsj.com/articles/chinasshortest-day-will-prolong-the-pain-1452160581. 

11 Lingling Wei, “China Securities Regulator to Suspend New ‘Circuit Breaker’ Mechanism,” Wall Street Journal, January 7, 2016. 

http://www.wsj.com/articles/china-securities-regulator-to-suspend-new-circuit-breaker-mechanism-1452179748. 

12 Jake Van Der Kamp, “Why China Should Just Let the Stock Market Crash,” South China Morning Post, January 6, 2016. 

http://www.scmp.com/business/markets/article/1898413/why-china-should-just-let-stock-market-crash. 

13 Deutsche Welle, “The Shanghai Stock Exchange: Where the State Does its Trading,” August 25, 2015. http://www.dw.com/en/theshanghai-stock-exchange-where-the-state-does-its-trading/a-18670977; Eswar Prasad, “5 Myths about China’s Economy,” Washington 

Post, January 7, 2016. https://www.washingtonpost.com/opinions/five-myths-about-chinas-economy/2016/01/07/08a8d5e6-b4c4-11e5-

a842-0feb51d1d124_story.html.

14 Edward Wong and Chris Buckley, “Credibility of China’s Leaders Takes a Hit Along With Markets,” New York Times, July 9, 2015. 

http://www.nytimes.com/2015/07/10/world/asia/china-stock-market-crash-communist-xijinping.html?emc=edit_tnt_20150709&nlid=54726097&tntemail0=y; Charles Riley and Agnes Chan, “How China’s Media and Risky 

Trading Fueled Stock Market Crash,” CNN Money, July 7, 2015. http://money.cnn.com/2015/07/07/investing/china-stock-market-crash/. 

15 Bloomberg, “China State Funds Said to Buy More Shares after Market Rout,” January 8, 2016. 

http://www.bloomberg.com/news/articles/2016-01-08/china-state-funds-said-to-buy-more-shares-after-1-trillion-rout. 

16 Reuters, “China FX Reserves Fall $512.66 Bln in 2015, Biggest Annual Drop on Record,” January 7, 2016. 

http://www.cnbc.com/2016/01/07/china-fx-reserves-fall-51266-bln-in-2015-biggest-annual-drop-on-record.html. 

17 Eric Platt, “Global Rout Scythes $2.3 Trillion off Stock Markets,” Financial Times, January 8, 2016. 

https://next.ft.com/content/78b3c1ec-b5a6-11e5-8358-9a82b43f6b2f. 

18 Evelyn Cheng, “Stocks Off Session Lows, but Dow Still Off Triple Digits,” CNBC, January 13, 2016. 

http://www.cnbc.com/2016/01/13/us-stocks-open-higher-oil-recovery-china-eyed.html. 

19 Chris Giles, “World Economy Feels the Impact When China Takes a Knock,” Financial Times, January 7, 2016. 

20 Corrie Driebusch and Riva Gold, “Dow Tumbles Nearly 400 Points on China Worries,” Wall Street Journal, January 8, 2016. 

http://www.wsj.com/articles/global-stocks-fall-on-china-volatility-1452156855. 

21 Jeremy Herron and Joseph Ciolli, “U.S. Stocks Tumble as Global Equity Rally Falters, Oil Weakens,” Bloomberg, January 13, 2016.

http://bloom.bg/1Rm7yJY; Joseph Ciolli, “U.S. Stocks Rally From 3-Month Lows as Energy, Health-Care Lead,” Bloomberg, January 

14, 2016. http://bloom.bg/1SkRzMg.