The China Syndrome

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Stock markets in China (and as a result around the world) plummeted this week. Measures put in place by the Chinese government to calm such crashes seem to have had the opposite effect as traders couldn’t sell fast enough as markets fell. The government removed the measure and the market has grown calmer. They’ve also probably been fiddling around behind the scenes in order to try to control what is essentially a chaotic system.

Markets serve useful functions; over the long term they help shift capital from failing industries to emerging ones. Governments can influence markets – essentially use them – by changing tax laws and other arms-length measures to achieve certain public policy goods. Nothing new about that and nothing wrong either.

However, in the short term, markets are largely ruled by ‘irrational exuberance.’ This is what leads to massive overvaluing of some stocks and sudden crashes when the least little ripple hits the economic news. Perhaps this is not surprising. Eddie Murphy put it best in ‘Trading Places’ when he told a couple of crooked investment bankers (is that adjective redundant?) that they were ‘a couple of bookies.’ Which, on some days, is all the stock market is: an off-track betting shop.

It doesn’t help when clever fellows use high technology to game the system, gaining millions for themselves by using ‘flash trades’ to skim money from more legitimate stockholders and traders. And given the propensity for all markets to ‘phish for phools’ not as a reflection of intentional criminality but rather as a reflection of how unregulated or poorly regulated markets inevitably run, it is not surprising that useless investments may be promoted as rock solid.

So what is really going on in China? First and foremost we know that the Chinese economy is growing at a slower rate than it did over the last ten years. But it is still growing at rates that should make western nations green with envy. 6% is not a bad rate but it isn’t 10%. Simple math suggests that 10% was never sustainable but, hey, high finance is not for simpletons, right?

And that is part of the problem. Despite constant warning by investment houses (warning only there because the law requires it) that past results are not a prediction of future outcomes, most people – including bankers, business men and senior finance officials – don’t really seem to get it. Decisions made a few years ago to invest in sectors of the economy that were dependent on continued massive growth in China (and let’s not even get into the misreading of the economies of the other BRIC nations) are, at least in part, behind the current panic.

So, if you have a lot of money in the stock market, you are in for a rough ride. But as more than one person wiser than me has said – you shouldn’t invest in stocks if you aren’t prepared to lose all of your investment. So tough luck.

Unfortunately, a lot of us are dependent on pension funds that are also heavily invested in the stock market. Let’s hope those managers have their eye on the long term and not on the day to day exuberance of day-traders.

And that’s ten minutes.

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