Download Taiwan Stock Bubble Burst in the late 1980s: A

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
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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
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