For years, leading experts have been warning about an impending structural downturn in China's economy, a prospect that looks highly likely as the Asian powerhouse runs out of export markets, cheap labour, and "ghost cities" to build.

But few foresaw the dramatic crash in China's burgeoning stock markets, which arguably has foreshadowed other major international developments such as the Iranian nuclear negotiations as well as the Greek bailout drama.

In the span of a few weeks, China's stock markets have lost a staggering $3.4 trillion, an amount that is larger than the economy of most nations. The Shanghai index has lost 32 percent of its value since mid-June.

After relishing a meteoric rise in their shares earlier this year, many investors suddenly saw more than half of their entire wealth wiped out in China's casino-like stock markets.

As panic gripped investors in the country and beyond, the Chinese Communist Party enacted several draconian measures to stave off a complete free fall, leading to the suspension of half of the total trade in Shanghai and Shenzhen stock exchange markets.

Counting the Cost- China's stock market meltdown

While China's largely state-led economy is expected to overcome recent shocks in the financial markets, long-standing confidence in the political leadership has taken a major hit.

The ruling party is scrambling to restore confidence in its professed determination to liberalise the country's economy, while nervously anticipating growing discontent among an aspiring middle class which has been disproportionately hurt by the recent crash.

Xi must be obeyed

Fresh into power, Chinese President Xi Jinping promised a new era of prosperity and greatness for the Chinese people. Under the banner of "China Dream", he reassured his countrymen about the rejuvenation of China's historical glory under his watch.

After spending most of his political life as an economic reformer in the booming regions of Fujian, Zhejiang, and Shanghai, Xi also projected a steely determination to overhaul China's economy, which began to show signs of vulnerability.

One of Xi's major pronouncements was the ruling regime's new commitment to ensure market forces will begin to play a more "decisive role" in China's economy. This was a major policy shift on the part of the ruling Communist Party.

Throughout its first three decades of rapid expansion, China's economy relied heavily on public finances and infrastructure spending, state-owned enterprises, and unbridled exports anchored by cheap migrant labour.

Xi internalised the imperative to reorient China's economy towards a more consumer-based, private-capital-driven, and innovation-centred economy. It did not take long before Xi - and his deputy, Premier Li Keqiang - began to encourage frugal Chinese citizens to take some risks and start investing in stocks.

The aim was to raise new sources of capital, enhance the role of the private sector in corporate expansion and employment generation, and boost consumer confidence in the overall economy.

Casino capitalism 

Talk of an impending Chinese collapse, however, are unfounded. Despite the crash, the Chinese stock markets are still 80 percent higher than last year, while the role of financial markets in China is relatively minimal compared to the West.

 

The state-controlled media constantly bombarded the aspiring middle class to pour its money into the booming stock markets, creating an investment frenzy that eerily resembled the run-up to the multiple financial crises that gripped the United States a few years ago.

Since the end of Mao Zedong's reign, China's communist regime has sought to reconcile its Marxist ideology with capitalism by introducing a so-called "capitalism with Chinese characteristics".

It is a hybrid system that heavily draws on the experiences of Meiji Japan and post-war South Korea, Taiwan, and Singapore, where autocratic regimes successfully played a leading role in establishing the foundations of modern capitalism.

Xi's reforms, however, pushed the Chinese economy closer to the Anglo-American model of capitalism, where overweening financial markets began to precariously play a critical role in determining the ebbs and flows of fortune. Suddenly, China was in the midst of its own financial mayhem.

But unlike in the West where institutional investors - like the Lehman Brothers - were at the forefront of the 2008 Great Recession, China instead saw the evisceration of the dreams of millions of middle class citizens and urban dwellers who invested the bulk of their wealth in casino-like stock markets.

Political implications

As Bloomberg economist Tom Orlik put it, the average new Chinese investor "had a lot less money, maybe not a white-collar job, and the most striking thing was that their average education level was high school dropout". By some estimates, up to 80 percent of Chinese urban households had invested, either directly or through equity funds, in the stock market before the crash.

Many feel that the regulators failed to prevent a bubble in equity markets, probably because they were too eager to ride on, or unwilling to rein in, the euphoria.

Worried about the political ramifications of the ensuing massive economic dislocation, the government employed a heavy-handed approach, imposing caps on short-selling, introducing temporary suspension in public offerings, encouraging pension funds to buy more stocks, and pushing the Central Bank to increase liquidity and cut interest rates.

Talk of an impending Chinese collapse, however, are unfounded. Despite the crash, the Chinese stock markets are still 80 percent higher than last year, while the role of financial markets in China is relatively minimal compared to the West.

The state's heavy intervention to arrest the free fall, however, belied its professed commitment to allow markets to play a "decisive role", reducing investors' confidence in market reforms.

Confidence in the Xi administration has also taken a hit, with many people complaining about the Chinese top leaders' conspicuous silence throughout the crash. In fact, Xi instead chose to attend a summit in Russia.

Many wonder how the ruling regime would respond to a more serious economic crisis in the future. Xi will face an uphill battle in reselling his "China Dream" vision to a sceptical, if not apoplectic, urban middle class. 

Richard Javad Heydarian is a specialist in Asian geopolitical/economic affairs and author of "Asia's New Battlefield: US, China, and the Struggle for Western Pacific".

The views expressed in this article are the author's own and do not necessarily reflect Al Jazeera's editorial policy.

Source: Al Jazeera