Mar 5 2007 4:54AM | Permalink | Email this | Comments (0) |
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Monday's panic in the stock market is a jolting reminder that "it’s a small world after all" in case you have not been to Disneyland or Disneyworld recently. The stock market index plunged 9% in China in a single day when the Chinese government announced plans to limit excessive speculation and investigate securities fraud. As a result the Dow Jones Industrial Index dropped 400 points, over 3%, shortly before closing. The index had been down over 500 points earlier in the day.

High price volatility and more decline is likely over the next few weeks as investors rebalance their portfolios and some margin investors are forced to liquidate their holdings. But the economy will shake this off just as it has previous financial shocks. The 500 point drop in October 1987 had no noticeable impact on GDP for that quarter. Note that construction will benefit, at least temporarily, from the drop in interest rates that accompanied the drop in stock prices.

As recently as five years ago a 9% plunge in the Chinese Stock Market Index would be reported in the financial pages of only the largest US newspapers. But now it is headline news in every newspaper. This is because China now accounts for over 25% of the total annual growth in the world economy. China is a much smaller share of the world economy if Chinese GDP is converted to $US using the exchange rate reported daily in the financial media. But savvy investors knew that the conversion has to done with “purchasing power parity “exchange rates to properly measure Chinese buying power in the world market. China accounts for more the world economic growth now than Europe and Japan combined. What happens in China matters for business in the US. An economic collapse in China would sharply cut US exports but more importantly would raise the cost and disrupt the supply of US imports and disrupt the manufacturing supply chain around the world.

There is little risk of an imminent collapse in the Chinese economy. The equity market is much less important to the economy in China than it is in the US. The Chinese are operating their economy near the boiling point so periodic bubbling over has to expected. In this instance, speculators got overly exuberant. They knew this and retreated quickly when the government threatened criminal penalties for the worse excesses. Abrupt bubbling over episodes will occur again as long as government fiats remain as important to profits as market demand and supply changes and information about the Chinese economy and Chinese companies remains fuzzed up by the lingering remnants of China’s earlier socialist economic and financial accounting systems.