Sophisticated investors in China market were taught how to interpret various warning signs from the government correctly and act accordingly. When they study the historical china market patterns they can always find there are almost no exceptions that the correlation between various warning signs from the government and the following market performance are very strong as Figure 1 and Figure 2 illustrated. The latest and the most famous example is the one between 2006 and 2007 when the Shanghai Composite Index (000001.SS) rose from 998 to its all time high 6124 in two years. Excess liquidity was blamed for the surge. The government rose ten times deposit reserve ratio within one year to reduce liquidity. The market reacted by a free fall from 6124 to 1706 in the following year. Then the government imposed four times rises on the same ratio since September 2008. The following market surge proved this correlation again.
Figure1. M1, M2 trends
Source: The People's Bank of China
Figure 2. Shanghai Composite Index since 2004.11[/img]
