Thursday, March 01, 2007

China Burps Greenspan Farts Dow Hiccups

File this under; loose lips sink ships.

On Monday, Greenspan said a recession was possible, though it's difficult to predict the timing, a comment blamed in part for the global market decline this week.

Greenspaned the works. He actually speculated that America may be facing a recession. But now noticing the stink in the room he is waving his hand behind his butt to clear the air.US slump possible, not probable-Greenspan quoted

Then the Chinese government which is still unfamiliar with the operations of capitalism speculated on capital gains taxes, and the Chinese stock market listened, and crashed.

One does not speculate out loud about such things when you have a stock market. The market responds as it did to Greenspan's comments. Sighs for the good old days were heard through out the Chinese hierarchy.

But why the panicked selling in China? It certainly wasn't because of anything Greenspan said. Most news reports are declaring that it was the result of rumors about potential policy initiatives that the Chinese leadership might soon enact to cool off an economy that is growing too fast. Whether Premier Wen Jiabao is about to announce interest rate hikes or a capital gains tax is impossible to say, but what we do know is that the leadership is very concerned with attempting to rein in China's reckless growth. And that's probably a good thing for everyone.

So when Shanghai sneezes, the world's markets catch the bird flu? True or not, the fact that this story is even being told is testament to how far and how fast China has come. It's instructive to think back 10 years, to the Asian financial crisis of 1997. China managed to keep itself relatively immune from the devastation that ransacked its neighbors, in part because of its iron grip on its own currency, and possibly because it was less well integrated into the global economy than the rest of the region. Ten years later, it's China that's shaking up the status quo, with a little help from the United States. From that vantage point, the fact that on Wednesday the Shanghai stock exchange, so far, is keeping its cool could well be the single most significant data point in all the market madness racing around the globe over the past 24 hours.

The reality is that in 1997 China had NO international stock market and did not yet own the ultimate capitalist safe haven; Hong Kong. So the Yaun was protected by the Chinese and their stock market, being internal, did not suffer the meltdown the rest of the world did.

In this case China came of age, and created a global meltdown on what was a local event.

Pick a stock market, any market in our globalised, homogenised, sterilised, aneasthetised, dumbed down, interconnected ever shrinking globe... and it tanked.
But the original epicentre was somewhere new...that emerging sleeping giant that even Napoleon worried fleetingly about...China. Shanghai’s A share index – ie for Chinese investors only - slumped 9%.

Today it is a different world and China owns the majority of America's debt. And its stock market is now a world market place despite being a creature of the Chinese State.

China’s stock market had three unique features that made its rapid
development unique and interesting.

First, the government used it largely as a fund raising vehicle for
funding state-owned enterprises
Second, China’s stock market developed under a repressed financial
regime. Financial repression was created through a combination
of capital controls on international capital flows and administrative
measures imposed by the central government to dampen potential
competition among different financial assets (e.g., bank deposits, enterprise
stocks, enterprise bonds, and various kinds of government
bonds) within the domestic financial sector.5 While the capital controls
helped to prevent capital from flowing out of the country, the
competition-mitigating administrative controls sought to avoid the
driving up of returns on various financial assets and thus to allow the
government to maintain a source of cheap capital for financing SOEs’
Third, China’s stock market was developed under a weak legal
framework that offered shareholders little protection. On the widely
used indicators for shareholder rights protection developed by La
Porta et al. (1998), China scored 3, compared with the average score
of 3.61 for all other transitional economies.
The actual protection for shareholders in China, however, is lower
than what the index suggests because of the weak legal enforcement
in China. The development of China’s stock market therefore
presents a puzzling case for economists and financial analysts who
hold that legal shareholder protection is a prerequisite for the development
of a functioning capital market

So the result was a crash heard around the world. The reason is three fold, China burped, Greenspan farted and America had lower than expected trade income (from durable goods) thus they owed the Chinese even more money.

What happened Tuesday was a confluence of events, something of a "perfect storm," each of which precipitated pent-up doubts. There was the decline overnight of 9.2 percent in the Chinese stock market, in which U.S. investors purchased $5.2 billion in equities in 2006. Then there was a decline in orders for durable goods and Mr. Greenspan's comments.

Correction or Crash is the question on everyones lips this morning on day three of the crumbling of stock markets world wide. It's a crash. Just not a 1929 crash. Heck it isn't even a 1987 crash. Nor a 1997 meltdown. It's a hiccup the stock markets world wide are a thousand times higher than 1929, and in 1987 the stock market was only at 5000. Today it is over 12,000 in North America and around the world. But a crash none the less.

That was the ultimate Perfect Storm, as the 1987 crash proved. In 1987 the crash was as severe as it was in '29 but the impact was the clearing out of junk bonds, as it had been in '29 a clearing out of Mutual Funds, and other get rich quick schemes, and companies that collapsed were quickly bought up by those cash rich, which did not occur in '29.

The 1987 market crash, which greeted Greenspan just two months into his term and drained the stock markets of nearly one-quarter of their value in a single day, was widely thought at the time to be a precursor of recession. But the Fed chairman, beginning to establish his reputation for working miracles, avoided the inevitable by guaranteeing to pump enough money into the economy to keep anyone from going broke for lack of cash.

What folks forget in bull markets and boom economies, such as we have seen for the past twenty years is that crashes become cycles, called corrections by optimists, but the business cycle of the early 20th century are no longer as damaging to capitalist society as they were in 1929. Thanks to Keynes. Notice that even an Ayn Randist like Greenspan is not adverse to priming the pump to protect the Stock Market.

There was no priming the pump for the 1929 Wall Street Crash, as Keynes noted at the time. As Galbraith writes in his history of the Great Depression.

Galbraith writes with great wit and erudition about the perilous actions of investors and the curious inaction of the government. He notes that the problem wasn't a scarcity of securities to buy and sell: "The ingenuity and zeal with which companies were devised in which securities might be sold was as remarkable as anything." Those words become strikingly relevant in light of revenue-negative start-up companies coming into the market each week in the 1990s, along with fragmented pieces of established companies, like real estate and bottling plants. Of course, the 1920s were different from the 1990s. There was no safety net below citizens, no unemployment insurance or Social Security. And today we don't have the creepy investment trusts--in which shares of companies that held some stocks and bonds were sold for several times the assets' market value.

In 1929 Joe and Jane America were invested in the stock market for the first time through Mutual Funds, which were the junk bonds of their day. Workers , small businessmen, seniors, all could afford to invest in stocks. Gone were the days of the Robber Barons dominating the sanctuary of Wall Street.

Like insurance companies of the time, Mutual Funds and other stock market options were being peddled to the working class. For the first time ever in the boom economy of the Post War 1920's workers were secure in their jobs and could afford homes, cars, and yest putting a little aside for retirement either through insurance, bank savings, saving and loans mortgages or through stocks and mutual funds.

The perfect storm was the complete collapse of market capitalism, one that had no social safety net. Workers lost homes, business collapsed and the state called for chickens in every pot but provided no jobs. The chickens came home to roost for the free marketeers,their ideology was laughed at as irrelevant in light of historical facts of the crash and empirical fact's behind it. The U.S. market never recovered until the space age.

Over the long run, a European investing on Wall Street might do fairly well. But what if he had invested in the late ’20s, when America’s promise and success seemed most inevitable? Just ask the Ghost of ‘29. If he had invested his money just before the crash, he would have had to wait until ‘56 to break even! That is, he would have had to hold on through a Great Depression…another major world war…and practically until the end of the Eisenhower administration - a period of 27 years! After that, he would have enjoyed a good 10 years of capital growth - and then another setback.

Like today many folks are invested in the Stock Market, but mainly through their retirement savings, thus the impact on real cash, real value is softened. State capitalism saves the day, meaning crashes are reduced to corrections, the business cycle levels off instead of being a desperate spiral to Depression, and all is well with the world. Thus this weeks downward spiral is a hiccup instead of a stroke.

And while Rothbard would deny Keynes or Galbraiths solutions were valid, which history proved they were, his work on the Great Depression also shows that the much vaunted Free Market failed because it was dominated by criminal capitalists trying to make a fast buck. Something the right wing liberaltarians never consider in their free market mythology. But which is the reason for all such meltdowns in the marketplace as Enron showed.

The ability to now regain from a crash is part of the checks and balances of the stock markets, whether through state regulations, investor funding or computerization. And thus the need to continually keep armed, to have little wars world wide, are now part of the business cycle as well. Gone are the days when rearmament could save the market, today it is key to the well being of the market place.

The bull market effectively came to an end on September 3, 1929, immediately the shrewder operators returned from vacation and looked hard at the underlying figures. Later rises were merely hiccups in a steady downward trend. On Monday October 9, for the first time, the ticker tape could not keep pace with the news of falls and never caught up. Margin calls had begun to go out by telegram the Saturday before, and by the beginning of the week speculators began to realize they might lose their savings and even their homes. On Thursday, October 12, shares dropped vertically with no one buying, and speculators were sold out as they failed to respond to margin calls. Then came Black Tuesday, October 19, and the first selling of sound stocks to raise desperately needed liquidity.

So far all was explicable and might easily have been predicted. This particular stock market corrective was bound to be severe because of the unprecedented amount of speculation which Wall Street rules then permitted. In 1929 1,548,707 customers had accounts with America's 29 stock exchanges. In a population of 120 million, nearly 30 million families had an active association with the market, and a million investors could be called speculators. Moreover, of these nearly two-thirds, or 600,000, were trading on margin; that is, on funds they either did not possess or could not easily produce.

The danger of this growth in margin trading was compounded by the mushrooming of investment trusts which marked the last phase of the bull market. Traditionally, stocks were valued at about ten times earnings. With high margin trading, earnings on shares, only one or two percent, were far less than the eight to ten percent interest on loans used to buy them. This meant that any profits were in capital gains alone. Thus, Radio Corporation of America, which had never paid a dividend at all, went from 85 to 410 points in 1928. By 1929, some stocks were selling at 50 times earnings. A market boom based entirely on capital gains is merely a form of pyramid selling. By the end of 1928 the new investment trusts were coming onto the market at the rate of one a day, and virtually all were archetype inverted pyramids. They had "high leverage"—a new term in 1929—through their own supposedly shrewd investments, and secured phenomenal stock exchange growth on the basis of a very small plinth of real growth. United Founders Corporation, for instance, had been created by a bankruptcy with an investment of $500, and by 1929 its nominal resources, which determined its share price, were listed as $686,165,000. Another investment trust had a market value of over a billion dollars, but its chief asset was an electric company which in 1921 had been worth only $6 million. These crazy trusts, whose assets were almost entirely dubious paper, gave the boom an additional superstructure of pure speculation, and once the market broke, the "high leverage" worked in reverse.

Hence, awakening from the pipe dream was bound to be painful, and it is not surprising that by the end of the day on October 24, eleven men well-known on Wall Street had committed suicide. The immediate panic subsided on November 13, at which point the index had fallen from 452 to 224. That was indeed a severe correction but it has to be remembered that in December 1928 the index had been 245, only 21 points higher. Business and stock exchange downturns serve essential economic purposes. They have to be sharp, but they need not be long because they are self-adjusting. All they require on the part of the government, the business community, and the public is patience. The 1920 recession had adjusted itself within a year. There was no reason why the 1929 recession should have taken longer, for the American economy was fundamentally sound. If the recession had been allowed to adjust itself, as it would have done by the end of 1930 on any earlier analogy, confidence would have returned and the world slump need never have occurred.

Instead, the stock market became an engine of doom, carrying to destruction the entire nation and, in its wake, the world. By July 8, 1932, New York Times industrials had fallen from 224 at the end of the initial panic to 58. U.S. Steel, the world's biggest and most efficient steel-maker, which had been 262 points before the market broke in 1929, was now only 22. General Motors, already one of the best-run and most successful manufacturing groups in the world, had fallen from 73 to 8. These calamitous falls were gradually reflected in the real economy. Industrial production, which had been 114 in August 1929, was 54 by March 1933, a fall of more than half, while manufactured durables fell by 77 percent, nearly four-fifths. Business construction fell from $8.7 billion in 1929 to only $1.4 billion in 1933.

Unemployment rose over the same period from a mere 3.2 percent to 24.9 percent in 1933, and 26.7 percent the following year. At one point, 34 million men, women, and children were without any income at all, and this figure excluded farm families who were also desperately hit. City revenues collapsed, schools and universities shut or went bankrupt, and malnutrition leapt to 20 percent, something that had never happened before in United States history—even in the harsh early days of settlement.

This pattern was repeated all over the industrial world. It was the worst slump in history, and the most protracted. Indeed there was no natural recovery. France, for instance, did not get back to its 1929 level of industrial production until the mid-1950s. The world economy, insofar as it was saved at all, was saved by war, or its preparations. The first major economy to revitalize itself was Germany's, which with the advent of Hitler's Nazi regime in January, 1933, embarked on an immediate rearmament program. Within a year, Germany had full employment. None of the others fared so well. Britain began to rearm in 1937, and thereafter unemployment fell gradually, though it was still at historically high levels when war broke out on September 3, 1939. That was the date on which Wall Street, anticipating lucrative arms sales and eventually U.S. participation in the war, at last returned to 1929 prices.

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