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Taiwan Stock Bubble Burst in the late 1980s: A Lesson for Current China Stock Bubble By Jack Wu Ph.D. in Economics, University of Michigan Professor at National ChengChi University (NCCU), Taiwan The burst crisis of China stock bubble recently caught a lot of attentions from international societies. The Shanghai stock composite index significantly dropped from 5178 points on June 12th to 3373 points on July 9th. In other words, it dropped by 34.85% in only three weeks. Moreover, on July 13th, it suffered its worst oneday drop (8.5%) since 2007. As a matter of fact, Chinese government and state-controlled media should be responsible for blowing up the stock bubble. Prior to June 12th of June of this year, Shanghai stock composite index had continuously increased by approximately 150 % in about a year. State-controlled media told investors that the China stock boom was the affirmation of president Xi’s economic policies and urged them to buy more stocks. Therefore, the number of individual investors in the stock market was increased significantly to reach 90 million (about 9% of China Population). According to the historic experiences, most of Chinese individual investors believed that the stock indexes would continue to grow because the communist government would definitely make it happen for the social stability reason. However, their dreams were suddenly broken because the indexes significantly fell in a short period of time and a lot of them bought shares at the relatively high price levels. The burst of stock bubble would definitely threaten the social stability of China. Therefore, the Xi government tried very hard to prevent this from happening. For instance, both the interest rate and reserve requirement ratio were lowered. Moreover, the Chinese government even allowed the individual investors to use their homes as collateral to borrow Article written by Jack Wu for Business Cycles money to buy stocks. Furthermore, it banned the major company shareholders from selling shares for six months. However, it seems that these policies have had limited impacts so far. What is it going to happen in China if stock bubble actually bursts? The burst experience of stock bubble in another society near China a few decades ago may be able to provide us some answer for this question. The economic development of Taiwan occurred relatively earlier than China’s. Up to the end of 1980s, Taiwan had experienced a fast economic growth over three decades (on average 9% annual GDP growth rate). Due to a large accumulated amount of trade surplus with USA and Europe, the accumulated foreign reserve amount (70 billion US dollar) became the second largest one (Japan was the number one) in the world in the end of 1980s. Because of American government’s pressure on solving the trade imbalance problem, Taiwan’s central bank decided to give up the long-lasting fixed exchange rate policy (40 NT$/ US$) and adopted a floating exchange rate policy. The value of New Taiwan Dollar was expected to appreciate significantly, so a lot of foreign money flew into Taiwan. As a result, New Taiwan dollar appreciated quickly to 25 NT$/US$. At the same time, the wage level was raised significantly. In particular, the annual bonuses in private sectors were raised dramatically. Therefore, the general household’s income and wealth increased dramatically. As a result, the money supply of the economy increased significantly. Due to too much liquidity in the economy, real estate prices doubled in the short time. Real estate markets had already faced a bubble problem, so investors started to find alternative investment opportunities. The stock market where the weighted index was only 2298 points in the end of 1987 became their new target. Since the beginning of 1988, the weighted index had increased quickly. It went up to 8000 points in August of 1988. Although Taiwanese government warmed the investors that it would levy capital gain taxes in order to shrink stock bubble, but most Taiwanese investors still Page 1/2 believed that the weighted index would reach 10000 points. They strongly believed that government who needed voter’s supports would not make the bubble burst. As a matter of fact, the government did finally give up the adoption of capital gain tax policy in order not to anger the investors, so the weighted index quickly jumped up to 12495 points in the beginning of 1990. All of sudden, buying stocks became a nationwide activity. The number of investors in the stock market jumped up from 0.6 million in June of 1988 to 4.6 million in March of 1990. These new investors included housewives, students, and civil servants who were not traditional stock investors. Ninety percent of the stock transaction volumes were made by individual investors who only sought for short term speculation. The stock market became a big casino. Although the government had realized that Taiwan’s stock market faced the potential bubble crisis, it did not dare to take any action to cool down the stock market heat wave. Some politicians even tried to manipulate the stock market for their own interests. Therefore, individual investors kept blowing up the bubble. As a result of stock bubble, many Taiwanese households quickly made significant amount of money from stock market. Traditionally thrifty Taiwanese began to change their consumption behaviors. The luxury service industry and illegal adult industry (prostitution and gambling) grew quickly. At the same time, the crime rate climbed up significantly. The international media called Taiwan as Republic of Casino instead of Republic of China (ROC, the official country name of Taiwan) at that time. investors already withdrew money from Taiwan stock market in advance, so the big loss was borne mainly by domestic individual investors. In fact, almost all domestic investors were losers. As a result of the burst of stock bubble, most speculative investors were pulled away from the stock market. Taiwanese tried to find back their lost merits such as thrifty and diligence. Taiwanese investors who are still participating in the stock market have become more rational and more knowledge-based. As a result, Taiwan stock market has gradually become one of important Asian stock markets. Moreover, the burst of stock bubble became the turning point for Taiwan to upgrade its industry. Since the early 1990s, Taiwan has gradually transformed itself from a labor-intensive manufacturing factory to a high tech hub in the world. Based on Taiwan’s experience, I believe that China’s stock bubble will eventually burst. The only question is when it will happen? If it actually bursts, then majority losers will be those individual investors. One thing that Chinese government should do is to stop making bubble become even bigger by using various intervention methods. Alternatively, it should make the bubble shrink gradually. As long as the bubble does not burst suddenly, the negative impact will be smaller. Statecontrolled media should start to educate the individual investors that they should be careful about the burst crisis of stock bubble in China. Taiwan’s stock bubble finally burst in 1990. In order to solve a variety of social problems caused by the stock bubble, Taiwanese government decided to raise the interest rate, and provided more alternative financial investment options, and fought with illegal financial activities. Moreover, the Gulf war badly influenced Taiwan’s economy in the same year. Therefore, the Taiwan stock weighted index fell significantly from the record high 12495 points in the beginning of 1990 to 2485 points in October of 1990. Most of international Article written by Jack Wu for Business Cycles Page 2/2