The fall in the Chinese stock exchange followed a switch in sentiment, with investors appearing to finally heed warnings from regulators that stock prices were vastly overvalued.

Greenspan

Comments from Alan Greenspan, the former Federal Reserve chairman, and rising tension about Iran's nuclear programme also served to undermine investor confidence.

Greenspan had warned on Monday that the US economy had been expanding since 2001 and that there were signs that the current economic cycle was coming to an end.

An investment manager at Meeschaert, Alice Lhabouz, said analysts had interpreted Greenspan's comments as a concerted effort by the Federal Reserve to calm financial markets after recent sharp increases.

Francois Xavier-Chevallier, an analyst at French brokerage Credit Mutuel CIC,  said that Greenspan "thinks that it is better to have a little crisis now rather than a big crisis at a later date".

Global falls

In London, the FTSE 100 lost 2.31 per cent to close at 6,286.10 points, in Paris the CAC 40 shed 3.02 per cent to 5,588.39 points while in Frankfurt the Dax fell 2.96 per cent to 6,819.65 points.

In midday trading in the US, the Dow Jones Industrial Average showed a loss of 1.08 per cent to 12,495.27, while the tech-dominated Nasdaq composite tumbled 1.70 per cent to 2,462.05.

The broad-market Standard and Poor's 500 index shed 1.14 per cent to 1,432.88.

Reasons

In London, as well as concerns about the Chinese economy, mining shares were rocked by reports that the South African government was considering imposing a "windfall tax" on the resource industry.

Michael Davies, a Sucden analyst, said: "The FTSE 100 suffered heavy losses under pressure from sliding mining stocks ... after China's main stock index plunged almost nine per cent."

Xstrata plummeted 10.28 per cent to 2,383 pence in London, BHP Billiton lost 6.16 per cent to 1,051 pence and Anglo American shed 4.68 per cent to 2,507 pence.

In Paris steel-maker Arcelor Mittal dropped 5.61 per cent to 38.73 euros.

In Frankfurt, cosmetic and cleaning product maker Henkel led the fallers with a plunge of 5.74 per cent to 108.80 euros.

Politics

Geopolitical concerns also loomed large over the markets after two members of the US-led forces and a US contractor died in an explosion outside an Afghan base where Dick Cheney, the US vice president, spent the night.

Iran's stand over its nuclear programme added to uncertainty after diplomats from six world powers pledged in London on Monday to work on a new UN Security Council resolution.

Fred Dickson, a DA Davidson market strategist, said global stock markets appeared "ripe for a modest pullback" on Tuesday

"Right now, the market needs a steady flow of positive fundamental earnings news to reignite a broad scale advance that would take the indices back to new highs," he said.

Neil Mackinnon, chief economist at ECU Group, termed the sell-off on Tuesday "a classic flight to quality".