Panics and Perspective

A clumsy Chinese attempt to rein in risky stock speculation caused the current debacle. We can think of China as the Wild Wild East, much like banking was in our own historical Wild Wild West.
Written by Dagny D'Anconia    Friday, 2 March 2007

While the Americans have gradually reduced the wild and wooly behavior of their banks etc., the newly capitalistic Chinese are only now getting a handle on it. Indeed, a clumsy Chinese attempt to rein in risky stock speculation caused the current debacle. We can think of China as the Wild Wild East, much like banking was in our own historical Wild Wild West.

The American stock markets had frequent panics back before the development of the Federal Reserve. Back then the amount of money in the markets was very low by today’s standards, and one devious wealthy speculator could engineer trouble. As the American markets became larger, and the Federal Reserve learned from experience, the panics in America became less pronounced.

It is hard to identify an American-started panic since 1929. One possible exception is the mini-crash on Friday the 13th of October 1989 which was in part the result of the Wild and Wooly junk bond market. Even the panics created in China and passed to the US have been progressively less pronounced in the US over the years. Drops have decreased from 1987 to 1997, and now in 2007. See for nice comparison graphs.

Panics since 1929 have had some similarities: In particular the recent stock market drop had some similarities to the 1987 drop:

Both stock market drops began in Hong Kong. From there they spread around the world with the sun. On October 27, 1997 there was also a mini crash - which once again started in Hong Kong. In that case the American market recovered with a sharp rebound upwards the next day in spite of the continued drop in the Asian markets. That crash (DJIA -7.18%) was less than the one Tuesday (-3.29%). That would suggest that this may be a micro-crash as opposed to a mini one.

Alan Greenspan was saying discouraging things of interest to the Chinese just before both drops. In the 1987 case Alan Greenspan had said that the dollar would be devalued. Similarly, yesterday Alan Greenspan had warned of a economic slowdown - and he did it via satellite link to a business conference in Hong Kong. He said "When you get this far away from a recession invariably forces build up for the next recession, and indeed we are beginning to see that sign.”

On Monday (the day before the drop) the Chinese government took steps to curb risky investment by banks in China. This was the apparent trigger in combination with the possible inadvertent assistance of Alan Greenspan. After the strong market reaction, the officials backtracked on their plans a day later in the press - however the real plans of the Chinese to protect their banks are opaque and steeped in rumor. The emotional damage has been done to the more wary investors.

The relative amounts of drop between the Chinese and the American stocks were about the same. Back in 1987 American stocks dropped about half of what the Chinese stocks did, and Tuesday at their worst they dropped roughly about half of what the Chinese stocks did. Even so, after a day of weak stabilization on Wednesday, the Asian market dropped again, albeit less, and the American market dropped overnight more than its “proportional amount. In the end of the day Thursday however, the DJIA was only down .28% which is very close to the theoretical proportional drop of about .3%.

The information leading up to both 1987 and today’s drop was not generally unusual in either political or economic terms. It was imposed from outside America, in each instance by the Chinese market, and thus did not make a lot of rational sense in America.

The US market may be considered a safe haven compared to China at this point due to America’s relatively experienced and stable banking. That may attract investment as well over the longer term. The real harm appears to already have been done and we are now just reacting.

Nevertheless, there was a DDI down signal today, and we may be entering a time of market drop for our own political reasons - most of which have to do with Hillary and the aimlessness approach of the Democrats to the Iraq war and Iran. Even before the Chinese contagion there were some domestic signs of it. In any case, it was alarming to investors that unknown events far away could cause such a change here, and the emotional effect has its own additional impact on the investors’ psychology.

The DDI has switched back and forth in the turmoil. It is currently down. Unfortunately since these “Asian flu panics” happen so rarely, there is little data on them. Thus this is great opportunity to learn about them. Tomorrow morning should be more revealing.

I hope you find this information helps add perspective on the events of the week.

Best Regards,