Will last week’s Shanghai two-step the sudden collapse and recovery in that city’s stock market be an invitation to the dance of death for world share traders?
A brief glance at history suggests that this might be worth some thought despite popular faith in the power of positive thinking to produce everlasting prosperity.
The Wall Street Stock Market Crash of 1929, which led to the 1930s Depression, was not a dramatic one-day event. ‘Confidence did not disintegrate at once,’ as the American economist, the late John Kenneth Galbraith recalled in his book, The Great Crash, 1929:
through September and into October, although the trend of the market was generally down, good days came with the bad. On the New York Stock Exchange sales were nearly always above four million, and frequently above five.
After the 1997 East Asian financial crisis, a reporter in Canberra asked Professor Galbraith, if the world was in for another depression. The Professor looked shocked. He rebuked the reporter, saying the word ‘depression’ was originally meant to mean nothing more than a mild economic downturn.
But he admitted it had developed a bad name. Economists began talking of ‘recessions’ instead, explained Gailbraith, but that, too, soon came to mean economic disaster. As a result, economists now speak of ‘corrections,’ said the Professor, ‘So what you are really asking me is whether we are in for a correction of truly catastrophic proportions?’
Once again, the world is facing precisely that question.
Even a sharp fall on a still relatively insignificant stock exchange like Shanghai’s shouldn’t produce too many shock-waves around the world. Investors don’t need to be told that share prices climb stairs slowly and steadily then plunge down lift wells. That’s accepted wisdom: Share Trading 101.
This time, however, there were world-wide repercussions (albeit brief) arising from this supposedly insignificant reverse. And it clearly rattled US President, George W Bush, who rang US Treasury Secretary, Henry Paulson, to ask what it all meant.
The reaction in Canberra was even more visceral. Peter Costello called a press conference to explain that the downturn wasn’t his fault even though nobody had said it was.
Costello had good reason to worry. ‘Directly and indirectly, we have a larger proportion of our population that owns shares than any other country in the world,’ he explained. ‘ You have seen a correction today which has been triggered by events in China, but the more important thing for Australia is the fundamentals,’ he said.
Costello said the Australian stock market was underpinned by profitable companies, strong employment and low inflation. He also admitted that there would be ‘fits and starts from time to time.’ And although China and Australia could still expect strong economic growth, the Treasurer also warned, that share trading is never ‘a one-way bet.’
These were clearly meant to be comforting words. But do the fundamentals of the global economy support them? The rolling repercussions that followed last week’s Shanghai shocks suggest that this is a particularly good time to let a little sunlight into dark places.
There are serious issues in both the Chinese and the US economies. The Chinese Government, for example, has been holding its currency the Yuan artificially low to keep the country’s exports strong. That has helped to make China the workshop (or sweatshop) of the world, exporting 65 per cent of all it produces.
But success has come at a price. The Chinese Government has been buying huge volumes of US dollars from exporters and foreign investors. It pays for them in Yuan; it then tries to soak up the liquidity this produces by issuing government bonds. Yet a huge amount of money still slops around the Chinese economy, producing local stock-market and real-estate bubbles.
China ‘s heavy dependence on the US market also carries risks. Especially when former US Federal Reserve Chairman Alan Greenspan a man clearly suffering from limelight deprivation syndrome warns that America might be on the brink of a recession. Greenspan’s successor, Ben Bernanke, has quickly tried to correct the damage caused by this suggestion. He says world markets appear to be ‘working well.’ He even predicted ‘moderate (US) growth’ this year.
However, new home sales in the US fell sharply in the opening weeks of the New Year and there are now big stocks of unsold houses. US lenders, too, are becoming more cautious, particularly with prospective clients who haven’t always met their debts promptly. Then there’s the US Department of Commerce, which reports that orders for cars, washing machines and other big purchases fell by eight per cent in January.
All this, on top of the Bush Administration’s reckless tax and military spending policies, suggests that superstar investor, George Soros, was right when he said that the world is more often out of whack, than in the state of equilibrium economists talk about.
The last big stock market crash, in 1987, hit Australia hard. We escaped more lightly from the subsequent Asian Economic Crisis.
Wise investors, though, will watch global markets, particularly those of China and the US, in the weeks and months ahead.
Peter Costello’s much vaunted ‘sound economic management’ in Australia might help. But it will be secondary.
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