China's Fine, but Beware the Stocks

But the biggest changes have been in regulations that cover all those state-held shares. Under the old rules, the government sold its shares in bulk on the basis of their net asset value instead of the much higher market price. That meant the government could either sell shares below market prices -- in volumes large enough to crush a stock and devastate the portfolios of the economic elite -- or do nothing. Not surprisingly, the government did nothing.

New rules that are being drafted now would require the government to sell its shares at market prices and in smaller lots no larger than 5% of the government's position. (Larger sales would require special permission from the state-owned Assets Supervision and Administration Commission.)

Because the new rules make limited selling less disruptive to the market and to the interests of the country's elite investors, it's logical to see the rules as the first step toward greater government sales of shares and a gradual decline in share prices until they are at par with those on the Hong Kong exchange.

Savvy investors in China -- those who work inside the government and corporate structures -- know how this can work. They've circled next week's National People's Congress on their calendars as the date when the new rules and a policy of greater government sales of shares could be announced. They know that in this meeting in 2005 Premier Wen Jiabao voiced concern about declining share prices, and that a few weeks later the government put into effect new rules on stock ownership that sparked an 18-month rally.

So the elite decided to hit the door first. Other investors, watching them, joined the rush. Soon the market was down 9%. And other markets joined the tumble as hot-money speculators there rushed for the door, just to be safe.

As I said, nobody should be surprised.