I received an email from one of my former students who wrote:
The Chinese stock market has plummeted more than 30% earlier this month, and although some think the market is stabilized, albeit after a heavy dose of policy interventions, I am not in that camp. As I have argued before in a number of fora, this is just another symptom of the global financial disorder and the situation in China, Greece, and soon in a number of other countries is only indicative of this disarray.
China’s stock markets, although about a third of her GDP, and playing a rather small role in that economy were artificially boosted when the monetary authorities tried to stimulate the economy at a time when the real economy was slowing down. Chinese stock markets, made up of a staggering number of small investors that were and are hunting for higher yields to park their savings. The crash is providing leading signals about the direction of China’s economy and its medium term outlook. Chinese savers who have been recently disappointed with their real estate investment encouraged by authorities to move into the stock markets in droves, and some heeded the call despite of being heavily in debt. They joined the fray, as would be the rational response of any utility maximizer when there are no other alternatives for managing the risks, smoothing of consumption, and planning for the retirement.
Just a quick glance at the Shanghai Se Composite Index (SSE) makes it quite clear that share prices were and still are overvalued, (at the time of writing, as the above chart indicates, it was more than 92 per cent higher than its level just a year ago). Thus, earlier this month when it became clear that share prices could not grow any further, profit takers exited the markets causing share prices to fall. As in a classic Minsky moment the fall created a panic, albeit a warranted panic, and as people rushed to exit it became a self-fulfilling prophesy – which of course was more than a “prophesy” as the fall was inevitable.
There were other factors that exacerbated the situation, e.g., some earlier margin calls. Then there were a number of misguided government interventions -- such as imposing a six-month prohibition on share sales by company directors or any listed shareholder who owned a 5% stake in the company, which compelled a rational investor to try to get out of the market while there’re still some possibilities!) Other desperate policies like the country’s Securities Regulatory Commission’s $19.3bn “market stabilization fund”, capping of short selling, pension funds pledging of buying more stocks, suspension of initial public offerings, limiting the supply of shares to provide support for prices, brokers creation of a fund to buy shares backed by central-bank cash and so on could not remedy the larger and more serious malaise of an imbalanced economy in a globally imbalanced world. The Chinese economy is badly distorted by following a lopsided export-led-growth model for far too long.
But the problem is not exclusive to China, and financial authorities everywhere are only postponing the day of reckoning for mere few more quarters while distorting the economy even further.
A similar first glance at S&P 500, does not show an abrupt rise like that of Chinese SSE, but perhaps the look is deceiving. The incredible surge of Federal Reserves’ balance sheet from a pre-crisis level of close to 800 billion dollars to a staggering 4.4 trillion dollars is disguised in the S&P 500 chart. However, a look the Fed's Balance sheet chart above sheds a convincing light on the argument that the steady rise of share prices in the US cannot be entirely divorced from what happened in China. Yes, as Milton Friedman used to say “inflation always and everywhere is a monetary phenomenon” and a greater part of this asset price inflation is also a monetary phenomenon. A Pandora's box that when opens up will be creating an enormous amount of misery.
Of course, this story is a global story too. The central banks’ balance sheets are not looking robust particularly in Europe and in Japan. The resolution of global financial predicament is unfortunately within the purview of the International Monetary Fund (IMF), which is fair to say, at best, has been totally out of touch and practically irrelevant. For example in its recent annual review of the U.S. economy, it has warned that regardless of when the Fed raises rates, the increase could trigger “significant and abrupt rebalancing of international portfolios with market volatility and financial stability.” One wonders why IMF thinks international portfolios are balanced?
The world seriously needs an international conference to tackle the global financial imbalance in the context of stabilizing a new orderly financial structure to support global trade. In a recent commentary about Greece’s bailout in this forum I have suggested that, the 1920 Brussels international conference and 1933 London conference can provide us with remarkable intellectual blueprints for an attempt to restructure international financial relations. I referred to the suggestions of the prominent Swedish economist Gustav Cassel who in Brussels conference had recommended a overbalancing of the world flow of funds based on Purchasing Power Parity. A Cassel type of PPP adjustment does not necessarily require a gold-standard regime. A return to a Purchasing Price Parity can be grounded on a composite index of industrial materials. This process would create a realistic correspondence between the nominal world of finance and the real world of goods and services. A global annual GDP of 75 trillion dollars does not need to be lubricated by 600 trillion dollars of toxic assets.
As I have argued before, “in the eve of the London conference of 1933, the British Prime Minister Ramsay Macdonald, who understood the significance of the need for a global restructuring to establish a global financial balance, opined that the conference might possibly save democracy from the world’s economic challenges.”
Did you read the current news about China's stock market fall in July? I read many analysis articles about this from Chinese media but I want to know what are the main reasons from a foreign professional scholar (you know, people read from Chinese media is always what the Chinese government let people know). Some say it is about the high leverage, and some say it's about foreign investors' speculative attack (involves Asian Infrastructure Investment Bank's signing ceremony). If possible, could you explain about this phenomenon a little bit please? Thank you for your time.After I responded, I thought it may be a good idea to share my thoughts with everybody, so here is a slightly revised version .
Towards a new global financial order
The Chinese stock market has plummeted more than 30% earlier this month, and although some think the market is stabilized, albeit after a heavy dose of policy interventions, I am not in that camp. As I have argued before in a number of fora, this is just another symptom of the global financial disorder and the situation in China, Greece, and soon in a number of other countries is only indicative of this disarray.
China’s stock markets, although about a third of her GDP, and playing a rather small role in that economy were artificially boosted when the monetary authorities tried to stimulate the economy at a time when the real economy was slowing down. Chinese stock markets, made up of a staggering number of small investors that were and are hunting for higher yields to park their savings. The crash is providing leading signals about the direction of China’s economy and its medium term outlook. Chinese savers who have been recently disappointed with their real estate investment encouraged by authorities to move into the stock markets in droves, and some heeded the call despite of being heavily in debt. They joined the fray, as would be the rational response of any utility maximizer when there are no other alternatives for managing the risks, smoothing of consumption, and planning for the retirement.
Just a quick glance at the Shanghai Se Composite Index (SSE) makes it quite clear that share prices were and still are overvalued, (at the time of writing, as the above chart indicates, it was more than 92 per cent higher than its level just a year ago). Thus, earlier this month when it became clear that share prices could not grow any further, profit takers exited the markets causing share prices to fall. As in a classic Minsky moment the fall created a panic, albeit a warranted panic, and as people rushed to exit it became a self-fulfilling prophesy – which of course was more than a “prophesy” as the fall was inevitable.
There were other factors that exacerbated the situation, e.g., some earlier margin calls. Then there were a number of misguided government interventions -- such as imposing a six-month prohibition on share sales by company directors or any listed shareholder who owned a 5% stake in the company, which compelled a rational investor to try to get out of the market while there’re still some possibilities!) Other desperate policies like the country’s Securities Regulatory Commission’s $19.3bn “market stabilization fund”, capping of short selling, pension funds pledging of buying more stocks, suspension of initial public offerings, limiting the supply of shares to provide support for prices, brokers creation of a fund to buy shares backed by central-bank cash and so on could not remedy the larger and more serious malaise of an imbalanced economy in a globally imbalanced world. The Chinese economy is badly distorted by following a lopsided export-led-growth model for far too long.
But the problem is not exclusive to China, and financial authorities everywhere are only postponing the day of reckoning for mere few more quarters while distorting the economy even further.
A similar first glance at S&P 500, does not show an abrupt rise like that of Chinese SSE, but perhaps the look is deceiving. The incredible surge of Federal Reserves’ balance sheet from a pre-crisis level of close to 800 billion dollars to a staggering 4.4 trillion dollars is disguised in the S&P 500 chart. However, a look the Fed's Balance sheet chart above sheds a convincing light on the argument that the steady rise of share prices in the US cannot be entirely divorced from what happened in China. Yes, as Milton Friedman used to say “inflation always and everywhere is a monetary phenomenon” and a greater part of this asset price inflation is also a monetary phenomenon. A Pandora's box that when opens up will be creating an enormous amount of misery.
Of course, this story is a global story too. The central banks’ balance sheets are not looking robust particularly in Europe and in Japan. The resolution of global financial predicament is unfortunately within the purview of the International Monetary Fund (IMF), which is fair to say, at best, has been totally out of touch and practically irrelevant. For example in its recent annual review of the U.S. economy, it has warned that regardless of when the Fed raises rates, the increase could trigger “significant and abrupt rebalancing of international portfolios with market volatility and financial stability.” One wonders why IMF thinks international portfolios are balanced?
The world seriously needs an international conference to tackle the global financial imbalance in the context of stabilizing a new orderly financial structure to support global trade. In a recent commentary about Greece’s bailout in this forum I have suggested that, the 1920 Brussels international conference and 1933 London conference can provide us with remarkable intellectual blueprints for an attempt to restructure international financial relations. I referred to the suggestions of the prominent Swedish economist Gustav Cassel who in Brussels conference had recommended a overbalancing of the world flow of funds based on Purchasing Power Parity. A Cassel type of PPP adjustment does not necessarily require a gold-standard regime. A return to a Purchasing Price Parity can be grounded on a composite index of industrial materials. This process would create a realistic correspondence between the nominal world of finance and the real world of goods and services. A global annual GDP of 75 trillion dollars does not need to be lubricated by 600 trillion dollars of toxic assets.
As I have argued before, “in the eve of the London conference of 1933, the British Prime Minister Ramsay Macdonald, who understood the significance of the need for a global restructuring to establish a global financial balance, opined that the conference might possibly save democracy from the world’s economic challenges.”
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