Market Correction

Posted: February 28th, 2007 | Author: saldarji | Filed under: business | No Comments »

As everyone has read in the papers, there was a small drop in the global equity markets, which was triggered by a drop in the Shanghai composite index. My sense is that this is the beginning of a much larger correction in the Chinese equities market. The situation reminds me of the Nikkei Bubble of the 80s. The speculation then was fueled by an expectation of hypergrowth, which is similar to the expectations in China. In addition, the Japanese had an unusual brokerage system, where brokers basically guaranteed their clients that the prices of stocks would continue to rise. In effect, it propped up the stock market far longer than it should have. This is similar to the Chinese market, only in China it is the government propping up the price.

The Chinese government is also a huge factor here. The government closely monitors the stock market. A large majority of listed companies are state-owned. The state also controls the brokerages and the biggest institutional investors. So naturally, the government has an incentive to prop up the market, and to prevent steep sell offs. – link

The interesting thing about bubbles is that there is often an assumption that the inevitable crash (and recovery) is quick. The stock market crash in 1929 actually occured over a week timespan and resulted in the Great Depression. Japan is still challenged economically by the excesses of the 1980s.

One concern right now is the fact that the Chinese are highly invested in US Treasuries. The unwinding of those positions could have some serious consequences for the dollar. Central banks are already cutting their holdings of the US dollar, in anticipation of an adjustment.

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