More than 30 percent has been wiped off the value of Chinese shares since mid-June.
Trading has been suspended in more than half the country's listed stocks.
With China's iron ore prices plunging to a six year low, economists are predicting a flow on effect to Australian miners and to the economy more generally.
China's securities regulator has taken the drastic step of banning shareholders with stakes of more than five percent from selling shares for the next six months.
The Chinese government has also enlisted the help of major stock brokers to set up a $26-billion stabilisation fund, aimed at stemming further losses.
The downturn in China's sharemarket is having a particularly negative impact on middle-income earners.
The Chinese government has actively encouraged the public to borrow money to purchase shares at a time when the property market has faced big losses.
Professor Kerry Brown is the Director of the China Studies Centre at the University of Sydney.
He believes the plummeting share prices in China will weaken consumer spending in the country, with direct implications for Australia.
"It's primarily about consumer confidence or middle class confidence. Those are the main people- the 80 million who had these accounts in the stock exchange- and those are the sort of people who we as Australian companies and service providers need to sell to. So this is not about supplying stock that we dig up out of the earth. This is about how we reach the consumers' pockets and the hearts and minds in China and at the moment, they'll be pretty worried hearts and minds. So it makes it that much more complicated a task."
The federal government estimates annual bilateral trade between Australia and China is currently around 159.6 billion dollars.
National Australia Bank Chief Economist Alan Oster says there is a general feeling of anxiety across the Australian sharemarket about the state ot the Chinese economy.
"It creates a lot of fear. Underpinning the Chinese economy as we've been looking at it, we've been thinking it's been looking a bit sad and a bit sick and a bit weaker than what the official data is showing. I think the most important effect is basically the fact that the iron ore price drops because people get more nervous about where the Chinese economy is going."
Mr Oster says it is also difficult to predict what direction the Chinese economy will take, because the country is not particularly transparent in its record keeping.
Neverthless, Professor Brown says Australia is likely to experience some real economic challenges ahead as a direct result of what's taking place in China.
"And it won't be months, I think it will be weeks. Almost daily the Australian dollar is weak and it's likely to get weaker if the issues in China continue. So that's the immediate impact. Of course that affects Australia's balance of trade. It affects the ability really to have international flows of trade. So there's already a knock-on effect. We are extremely exposed to the Chinese economy."
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