The economic spasm that could overshadow Greece

While much of the financial community's attention is riveted on Greece's debt crisis, another economic drama is playing out in China that could have a far great impact on the global economy.

China's stock markets have been falling rapidly for nearly a month, and by last week had dropped about 30 percent from its highs in mid-June. The plunge has erased $2.8 trillion in market value, or roughly 10 times the size of Greece's gross domestic product.

Chinese regulators have responded by halting initial public offerings, while hundreds of companies listed on the Shanghai and Shenzhen exchanges have asked that trading in their shares be suspended. That helped bring stocks in China out of their dive on Monday.

Yet many analysts, in China and abroad, are wondering where all this volatility might lead.

"If the government does not step in at this point, the panic sentiment will continue to spread and the stock plunge will deepen," Lu Ting, chief economist at Huatai Securities, told the state-run People's Daily on Monday. "It will risk a spillover to the banking sector, as many funds that flew into the stock market are from trust products sold by the banks."

According to the international financial data firm IG, state-owned newspapers in the People's Republic "have used their strongest language yet, telling people 'not to lose their minds' and 'not to bury themselves in horror and anxiety'. [Our] positive measures will take time to produce results."

After decades of historic growth, Chinese officials have been working to slow growth as part of a broader effort to shift from a manufacturing-based to a consumer-driven economy.

That has prompted concerns that the deceleration is too sharp. China's economic growth for the first three months of the year was the slowest in six years. There's also been anecdotal evidence that China's rate of "invisible unemployment" -- that is, a reduction in working hours and worker compensation -- is on the rise.

The slowdown is having a spillover effect on China's capital markets, which the government has nurtured as a way to smooth that transition and encourage personal consumption.

"These developments underscore the difficulties inherent in Beijing's financial reform agenda," Nicholas Consonery, an analyst with Eurasia Group, said in a client note. "No matter where prices go from here, the nearly 30 percent correction over the past three weeks is negative for the government's agenda to have equity markets emerge as a real financing mechanism for domestic firms and a bigger driver of household wealth."

Lei Mao, an assistant professor of finance at Britain's Warwick Business School, believes the Chinese government might be having trouble accepting the fact "that financial markets cannot be driven by policies and stock returns cannot be dictated by an authority. "

Meanwhile, some observers say it's time for the global economic community to shift its collective focus away from Europe.

"What happens in China will turn out to be far more consequential than any sting that Greece may deliver over the coming weeks or months,'' Frederic Neumann, co-head of Asian economic research at HSBC Holdings, said in an interview last week with Bloomberg News.

"As China's equity markets lose their roar, the risk is that demand more broadly on the Mainland could take a hit," he added. "That would knock out an essential engine of world demand over the past decade. As dramatic as events in Greece currently appear, however, ultimately, it's difficult to see these proving decisive for the world economy.''