I’ve been asked to discuss something that I don’t know much about, the Chinese stock market. So here goes:
1. Stock crashes are often predictions of bad times ahead. Sometimes they are correct (the US in 1929, 2008) and sometimes they are incorrect (1987). We know from 1987 that stock crashes don’t actually cause economic problems. Roosters don’t cause dawn. Chinese stocks are still much higher than a year ago, and the Chinese people won’t decide to stop working just because stocks crash. Indeed they may work even harder.
2. It’s possible that the Chinese crash is not a prediction of economic distress, but rather just a sort of mass panic. But the Australian dollar has been falling in sympathy with Chinese equities, which means that in this case it’s not just panic; it’s actual worry about a slowing economy. (Unless Australian mass hysteria is correlated with Chinese mass hysteria, which I doubt.)
3. Tyler Cowen often (wisely) points out that lots of things that superficially look stupid actually have good reasons if you look deeper. Here he speculates as to why the Chinese government might have wanted to prevent a stock market crash.
4. However even if Tyler is right, in this case the Chinese government probably is being stupid. The techniques they are using (such as banning the sale of many types of stock) will actually create more panic, and will lead to more sales from that part of the investment community that is still free to sell. Just as European governments that make it hard to fire workers end up causing higher unemployment, as people are afraid to hire them.
5. There’s a lesson here for “bubbles.” Even if you disagree with my view that bubbles are not a useful concept, there is very little evidence that governments can do anything about them. The Chinese government tried to stop the bubble on the upside, and then more recently tried to stop the price collapse. It tried hard. It failed miserably. China will learn from this lesson.
6. One reason why bubbles are not a useful concept is that it’s hard to tell what the right price should be in any “fundamental” sense. Some people thought 1987 was a bubble. After the huge price collapse of late 1987 they said, “I told you so.” At that point there seemed to be a consensus among experts that prices had gone way too high, and that a correction was inevitable. In fact, we now know that prices at the peak of the 1987 “bubble” (Dow 2700) were quite reasonable. (The Dow was 1700 after the crash.) If you bought at the peak and held stocks for 10 years, or 20 years, or 28 years (up to today) you did fine. So the experts were wrong. Thus even after an apparent bubble collapses, it’s really hard to know which price was right, the peak level or the later trough. In 20 years we’ll have a better idea whether the Shanghai market should now be at 5000 or
3500 3400 (down 100 since I started typing). Right now no one has a clue, just as no one in 1987 had any idea that the Dow would be at 17,000 today.
7. I’d rather the Chinese government stay out of the stock market, but this intervention is of trivial importance compared to the bigger changes occurring in China. I wouldn’t want the US government to spend a trillion dollars on Vanguard index funds, but if they did so it wouldn’t cause much of a problem. The tiny Norwegian government has almost a trillion dollars in stocks, and it doesn’t seem to have hurt Norway. There’s a lot of ruin in a nation as big as China, and China should be far more worried that the PBoC will fail to keep NGDP growing at 5% or more, and/or that Premier Li stops the economic reform process that’s been underway for 35 years, than about whether the Chinese government purchases some stocks.
8. When I first visited China in 1994 almost no one had cars or owned stocks. I was fascinated by the country, by the urgent moral issue of raising hundreds of millions of people out of abject poverty and misery. Quite frankly, I find the modern problems of pollution, traffic congestion and stock market crashes to be rather boring. Even today poverty is a much more urgent problem for China, but overall the situation is dramatically improved.