Why artificially propping up a stock market fails in the long run

Julie Brownlee, Fsp Invest, 23 Jul. 2015

Tags: stock market, stock markets, chinese stock market, stock market regulations, chinese stock market regulations,

A couple of weeks ago, the fall of the stock markets in China were hitting the headlines. In just four weeks, the market fell 30%. That’s $3 trillion worth of value gone.

To stem the fall, the Chinese government imposed a number of regulations to stop the selling of stocks, especially by big investors.

But is this a fix to the problem? Or is it delaying the inevitable?

Let’s take a closer look…

New regulations the Chinese government imposed on its stock market

With its stock market plunging, China’s government stepped in with a number of measures. These included:

  • Suspending initial public offerings. In other words, not allowing new companies to list.
  • Pushing pension fund managers and insurance companies to increase their holdings of Chinese stocks;
  • Not permitting stock brokers to sell stocks.
  • Forbidding listed company executives and directors from selling stocks if they have substantial holdings.
  • And halting trade on over 50% of the companies listed on the two Chinese stock markets.

So what’s going to happen when the government removes these restrictions?

You can’t stop a stock market from falling by using regulatory measures, Marc Lichtenfeld in Investment U explains…

Regulations to prevent a stock market falling just delay the inevitable

Look what happened in the US during the financial crisis. Regulators prevented the short selling of financial stocks, yet the Dow still fell nearly 19%. Financial stocks fell the most.

Or take September the 11th. The US closed its markets until 17 September. When they reopened, they lost 12% in one week.

It’s highly likely that once the Chinese government lifts the current restrictions, the stock market will continue to fall. Tough regulations like this actually deter future investment. Once investors can get their money out, many of them will.

Whilst it’s understandable why governments try to limit the impact of stock market crashes, historically it doesn’t work. In fact, if can lead to the very opposite happening when the regulations are removed.

So there you have it. Why artificially propping up a stock market fails in the long run.

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