As the immediate aftershocks of Shanghai rumbled through Britain, Europe and Asia the Australian market was dragged into the mire, falling 6 per cent over several days and wiping $68 billion in value from the market, especially those resource stocks most dependent on China's surging economy. Analysts are still grappling with the understanding of what went wrong that day. We are told it was an over-reaction and that it should never have happened, but the disconcerting fact remains, it did. Greg Hoy retraces the causes of the so called "Shanghai shock" on the stockmarket, to determine if there is much more volatility to come.
MICHAEL KNOX, ABN-AMRO CHIEF ECONOMIST: One must understand that the stockmarket is a place of risk and people had fallen asleep about that sense of risk and now they've had quite a shock awakening.
GREG HOY: The China syndrome with 1.37 billion people, economic growth last year of 10.7 per cent, a soaring trade surplus, industry growth of 23 per cent, China fever has driven world economic growth in recent years to great heights, dazzling global markets. Bullish investor sentiment has shattered record valuations on markets from Shanghai, which rose 130 per cent last year, to double digit rises across Asia; from London, across Europe, to New York, to Australia, trading records have been broken by the bulls from the China shop. Then on February 27, the crisis of confidence swept the global stock markets like a virulent virus, first believed to have started in China's largest equities market, Shanghai, which dropped 8.8 per cent in a day, the biggest fall in a decade.
CHINESE INVESTOR (TRANSLATION): I directly lost tens of thousands. A little bit more than 20,000 renminbi, all in one day. That was too scary. Our hearts can't bear it. We can't stand that much stress.
JASON CHANG, STANDARD CHARTERED BANK, SHANGHAI: The stock market has been growing too fast. At the end of 2005, the stock market was worth about US$400 billion and on Tuesday the crash, the correction happened, the stock market was worth about $1,500 billion. So that price is really fast and if that is to continue that is going to create some kind of bubble in the stock market and that's really going to be bad for the Chinese economy.
GREG HOY: And, like a virus, it has spread rapidly around the globe. Australia at first didn't react with alarm, but overnight the leviathan of global trading, the New York Stock Exchange, with its US$23 trillion in listed stocks, tumbled 400 points, the biggest fall since 9/11.
ALEC YOUNG, STANDARD & POOR'S, NEW YORK: Well, it was somewhat unusual in the sense that it was very sudden, so we went from a situation where the news flow and the fundamentals were excellent and the next minute we had basically a 6 per cent or 7 per cent sell off globally.
GREG HOY: And, not for the first or last time, when emerging markets falter, Wall Street sneezes and Australia starts sniffling.
MICHAEL KNOX: I think it's not implausible, though, to believe that that level of impact, that level of influence, will increase over the next year ahead and we will see much higher levels of volatility in the Australian equities market than we have been used to in the past year.
GREG HOY: The world's second largest stock exchange, with a market capitalisation of US$3.5 trillion, is London.
SIMON RUBENSON, BARCLAYS BANK, LONDON: I believe that a lot of the attention was focussed on the Chinese story because it is an interesting story, but I think that the more important point was however you look at it, whatever particular measure you want to take, risk was not really being fully priced, and that is not simply a London story but a global story.
GREG HOY: So did someone deliberately spook the bulls of investor sentiment and let the grizzly bears loose on the markets? Just prior to the Shanghai stock shock, in a satellite-televised speech to Hong Kong, the 81-year-old former head of the omnipotent US Federal Reserve, Alan Greenspan, predicted it was possible the world's largest economy, the US, would hit recession in late 2007, brazenly challenging the optimism of his replacement at the Federal Reserve, Ben Bernanke. It sent shock waves through China and well beyond. At the same time, the Bank of China had lifted the reserve deposit requirement for Chinese banks, to reduce the flow of funds into the ballooning stockmarket.
MICHAEL KNOX: You have to come to the conclusion that most of that rise is funded by debt, funded by margin lending. So by reducing the flow of credit into that market, so the Chinese Central Bank punctured the boom, they burst the bubble, and the bubble started to deflate.
GREG HOY: This shockwave from the world's second biggest economy exposed fault lines in the biggest - the United States.
ALEC YOUNG: What we started to see, beginning with the sell off in Shanghai, was investors start to discount some of the potential risks that there might be out there and most of them centre around a potential slowdown in global growth, most notably in the US as a result of some weaker economic data that we had, and also in China, with the efforts by the authorities there to maybe cool the red hot pace of growth.
GREG HOY: Britain, like Australia, saw its China dependent mining companies absorb most of the shock; for a sophisticated market, this was pure ignorance.
SIMON RUBENSON: The issue on metals was quite specific and it was related to events in China and fear the fallout from the Chinese equity market could actually damage the Chinese economy and Chinese demand for metals. I think that's a great leap of imagination. What happens in the Chinese equity market actually has very little bearing on the Chinese economy.
GREG HOY: Unlike its vast economy, the Chinese equities market is a minnow - the world's fifth-largest, though it is rapidly expanding, its volatility partly due to boutique market exchanges, where share trading is often conducted with borrowed money and treated more like a betting ring.
JASON CHANG: A lot of small chance investors are running into the stockmarkets and even students borrowing money from other sources to try to invest in the stock markets and that reflects their risk awareness of the Chinese stock markets is very, very low.
GREG HOY: But it is not just the Chinese borrowing that is increasing volatility in inflating stockmarkets. The same practice on a global scale, called the "carry trade", is conducted often out of Hong Kong and Japan, borrowing low interest currencies such as the yen to fund investments in countries like the US and Australia, with guesstimates up to a trillion dollars US. These huge capital movements have fuelled the great stock market rise of recent years, but when the market turns sour, this investment capital tends to abandon ship.
MICHAEL KNOX: I think the better adage is one of Robert Hamilton Holmes a Court, "in a bear market, the money returns to its rightful owners", and we've seen the Japanese yen get stronger in the last week. So money has returned to its rightful owners, in this case.
GREG HOY: Like the tide, the "carry trade" is now returning to the global markets, which have regained two thirds of their losses since the Shanghai shock. So many lessons have been learnt from the experience, even in China, where the growth trajectory continues, though now abated.
JASON CHANG: In the long run, as the Government is allowing more institutional investors and also more asset managers to allow into the market, you might see another boost to the stock market and, as the Chinese economy is growing, they need a bigger stockmarket to accompany their economic growth as well. So in the long run, the Chinese stockmarket is going to get much bigger.
GREG HOY: For now, all eyes are on the economic outlook for the US, still the subject of great disagreement between the former Chairman of the Federal Reserve, Alan Greenspan, and the current chairman, Ben Bernanke, the interests of Australian investors very much at stake.
MICHAEL KNOX: I think that Alan Greenspan is a very wise man.
ALEC YOUNG: At Standard & Poors we are still in Ben Bernanke's camp in the sense that our economists are expecting a soft landing for the US economy this year. So while it will slow as a result of a weakening housing market, they are expecting 2.4 per cent GDP growth and, while that does mark a deceleration, it still clearly is in soft landing territory.
MICHAEL KNOX: I think by the second half of this year the Fed will have to start cutting interest rates if it wants to stop the US economy falling into a recession. I think Alan Greenspan's comments were very well made.
GREG HOY: Such are the vagaries of global commerce, our fate inextricably entwined with America's, though the Australian economy is much stronger than theirs, because we have the resources boom and they don't. Thanks, primarily, to the growth of the dragon's economy - long may it last. - SOURCE: © 2007 Australian Broadcasting Corporation
Posted March 15th, 2007 by Armen Hareyan
