China has for long displayed signs of a classic stock market bubble. The dramatic collapse of equity prices this month suggests that the bubble could finally have popped. The rest of the world is finally taking notice. After all, the $10 trillion Chinese economy is around 40 times larger than the Greek one.

The Chinese version of the Greenspan Put has amounted to nothing more than a desperate attempt to fill air into a collapsing bubble; the interest rate cut last week was the fourth this year. And the rest of the policy response of the Chinese government to the market crash reveals a lingering central planning mindset, even though the Third Plenum of the Communist Party of China had famously resolved in 2013 the market process would play a decisive role in the economy.

The government has threatened short sellers, prevented large shareholders from selling, put new initial public offers on hold, ordered state agencies to buy shares to prop up the market, used a finance company owned by the government to lend $42 billion to brokers and backed a plan by a few top brokerages to buy $20 billion of shares. The Chinese market rallied on Thursday but such diktats can only work temporarily.

The recent market convulsions should be seen against the backdrop of what has happened in China over the past couple of decades. The greatest growth story in human history is now perhaps coming to an end.

China built its grand economic success by keeping down interest rates on its massive stock of domestic savings. Such financial repression allowed the Chinese government to lower the cost of capital for asset creation. There was also a massive expansion of credit after the 2008 global financial crisis. China essentially used the banking system rather than its government budget to stimulate the economy. Few realize that China now has a larger stock of money sloshing in its economy than even the US has after multiple rounds of quantitative easing.

Such a combination of massive monetary expansion and severe financial repression encouraged Chinese savers to seek returns in other asset classes. Housing was the preferred choice (as it continues to be in India). The end of the Chinese housing boom a few years ago meant that money began to flow into equities. Much of this was leveraged for speculative margin trading financed by brokers. It is no surprise that margin calls have now forced investors to sell in a hurry.

The Chinese government thought it could keep its people content with financial profits as the economy slowed. They preferred not to take the punch bowl away. But there is also a deeper historical lesson. Earlier examples such as the US in 1929 or Japan in 1989 show that an entire economy can suffer at the end of a stock market mania, especially when such mania is preceded by a decade or two of roaring growth. The sharp decline in global commodity prices points to a valid fear that China is headed for deeper trouble. The lack of clarity can make things worse. Remember it was the opacity of mortgage-backed securities in the US that made the panic worse in 2008. The financial markets froze because nobody was sure of what lay hidden in the books of various financial firms.

China operates under a different sort of opacity. There is very little clarity about how deeply the banks are exposed to the share market; what is the state of the large shadow banking sector; how much debt have the local governments taken on; how will the negative wealth effect of the stock market crash hurt consumer spending at a time when the Chinese government is trying to focus away from exports.

The Chinese economic model has been an outstanding success. But it is now in the midst of a rocky transition, as it moves focus from exports to domestic consumption, from capital accumulation to productivity growth and from capital controls to an international currency. The recent stock market meltdown highlight some of the challenges that the country now faces.

Is this the end of the Chinese boom? Tell us at views@livemint.com

Follow Mint Opinion on Twitter at https://twitter.com/Mint_Opinion-

Subscribe to Mint Newsletters * Enter a valid email * Thank you for subscribing to our newsletter.

Share Via