On Monday August 24, the main Chinese stock market, the Shanghai composite, fell 8.5 percent in one day. This massive drop set off losses worldwide, beginning in nearby Asian markets including Japan. However, the worry and lack of confidence quickly spread to Europe and to the United States. In the west, this led to massive sell-offs of stocks and the value of the American market dropping 10 percent below its record high, which was achieved only a few months earlier at the beginning of summer. While this was initially blamed on the volatility of the Chinese market and its slowing economic growth, the loss also revealed more issues in the other global markets. Read on to learn about the history of an up and down global stock market, the reasons for the recent crash, and what is expected in the future.

History of Volatility in the Global Stock Exchange

The recent stock market losses, while severe and brisk, are by no means the first and certainly not the worst that have occurred in history. Since ideas such as interconnected economies and even nations are relatively new concepts, to find the first major market crash one would only have to look back less than 400 years. This crash occurred in the Netherlands in 1637. Based on speculation, tulip prices in the country soared, leading many citizens to invest. But the prices eventually peaked and then plunged back to earth, causing many investors to lose everything.

Several more speculative bubbles grew and then burst over the ensuing years in economic powerhouses like Britain and France. The phenomenon would reach a head however, with the stock market crash in 1929 which ultimately led to the Great Depression. This stock market crash, like the ones before it, was the result primarily of speculation, which had been fueled by massive economic growth within the American economy during the 1920s.

However, when the economy began to stagnate, investors initiated a mass sell-off which caused the market to plummet. This was followed by a run on banks so severe that thousands were forced to close. The effects of this collapse spread beyond the borders of the United States to Europe, due to both places’ reliance on the gold standard. The Great Depression would play a major role in the lead up to WWII and it was not until after the war that the global economy recovered.

Despite the devastation of the 1929 collapse, major market meltdowns would continue to take place. In 1987 the U.S. market lost over a fifth of its value in just one day, a day known as Black Monday. The oldest bank in England, Barings Bank, was forced to close due to speculation. Meanwhile in Japan, following a thirty year growth spurt, the market collapsed beginning in 1989 and has left the country in a prolonged state of malaise ever since.

The two most recent crashes both originated in the United States. The first was at the turn of the millennium–the dot-com bubble. The bubble had built upon the belief that the internet was ushering in a new type of economy, which was not subject to the same issues as the past. This led to a number of unwise investments in companies mired in debt or with no value. The crash began in 2000 and continued into 2002. The bursting of this particular bubble cost the NASDAQ 80 percent of its value and led to a recession.

The most recent crash began in 2008.  From its pre-recession peak until the market bottomed out 18 months later in 2009, the Dow lost more than 50 percent of its value. This collapse was triggered by sub-prime mortgages, but spread to other industries such as automotives and was prolonged due to other connected issues globally, including the debt crisis in Europe. The economy was only saved and confidence only tentatively restored through massive bailouts.  The video below explains the 2008 crisis and the root of many of the stock market crashes:

Reasons for the Recent Crash

Like other crashes before it, the current crash is the result of a number of factors which have combined to cause speculation and panic on a global scale.

China

At the center of the most recent stock market crash is China. China had already been dealing with a declining market since at least June of this year. On June 12 the Chinese government stepped in to fill the void left by a bubble, which had been created by Chinese citizens investing money they did not have. While the government tried a variety of stop-gap measures, these appear to have had little effect. Compounding this problem more was China’s slowing growth. In fact, many of those who invested did so based on the prolonged growth of China’s economy for the last 20 years.

Additionally, confidence in China from the outside also appears to be faltering. This comes as a result of several recent events. The most glaring is the government’s inability to handle this current stock crisis. Even after intervening and devaluing the currency in an effort to make borrowing money cheaper, the market has continued to fall. Other events as well, such as the fiasco with a chemical plant explosion and China’s dubiously reported economic figures have caused foreign investors to lose confidence.

Commodities

Another area directly impacted by China’s recent crash is the commodities market. Commodities are things such as oil, gold, and copper. Many emerging markets, such as Brazil and Turkey, relied on selling commodities in order to build up their economies. However, with China losing vast tracts of wealth daily in its stock market, it can no longer buy as many commodities as in the past. This has resulted in less demand, which means reduced commodity prices and subsequent losses in the emerging markets reliant on them.

United States

Another area feeling a market correction, a loss of 10 or more percent, was the United States. Along with the news about China’s falling market, was the fear of the interest rate hikes in September, which would make borrowing money more expensive. While the United States is not the economic engine it once was, nor the borrower of last resort, it is still the world’s largest economy and any sudden crash in experiences would reverberate worldwide with even greater force than China.

Other Countries

Aside from the United States and emerging markets like Brazil, other places around the world also felt the crunch from China’s continued market crash. This included places like Europe, whose combined market had its worst losses since at least 2011. This also includes countries closer to home near China, such as Japan and Australia, each of whom saw sharp losses in the immediate wake of China’s loss. The accompanying video provides a thorough overlook of the recent Chinese Stock Market crash:

After the Drop

So with all the recent fluctuations in the stock exchange it bears asking, what is next for the world’s markets? The answer is seemingly more of the same. In the U.S. the Dow plummeted 588 points first on Monday, then another 204 points Tuesday. However, on Wednesday and Thursday the market rallied, gaining over 1,000 points in two days. The rally means that, for the week, the market is actually up. In fact the surge on Wednesday and Thursday marks the largest gain in any two-day period in the history of the American stock market.

Around the world, other markets were also experiencing a rebound on Thursday. In Europe and Japan, the stock market rose following dramatic losses earlier in the week. Even in China, the market rose more than five percent, ending a week of losses. In fact, even with all the recent losses, China’s market is still up 43 percent from a year ago.

However, even with markets quickly rebounding, China’s stock market crash cannot just be dismissed. The recent collapse has certainly shaken faith globally, for those who viewed China as the number one growth engine for the future. Furthermore, if this is unfortunately true, there is really no one to take China’s place. Emerging markets, such as Brazil, are overly dependent on commodities, Japan is still stuck in stagnation and Europe, as China’s largest trading partner, is too interconnected, especially as it still recovers from the 2008 crisis.

This leaves the U.S. as the world’s steadying force. While U.S. markets rebounded on the back of news that the GDP grew 3.7 percent in the second quarter, up from the original estimate of 2.3, and that jobless claims continued to fall, that status remains shaky.

Certainly, everything is not perfect in the American economy either. Following the recent market correction and due to the tumultuous world economy, the Federal Reserve has said it will probably not raise interest rates after all. This means that money can still be borrowed cheaply, however it also reveals the fear of weakness in the U.S. and global economies. This weakness is especially troubling because unlike before, when interest rates could be slashed, that option is no longer available. The following video looks at the future of the economy:

Conclusion

There is a saying that goes, “those who don’t learn from history are doomed to repeat it.” The history of the global stock market can offer many examples that attest to the validity of this sentiment. Throughout its history, the market has repeatedly surged and crashed, like waves against a beach. The recent case of China is just one more example of this situation. Luckily in this case though, the losses seem temporary and appear to offer no long-term threat to the global economy.

Nevertheless, the danger remains. This is due to the persistent existence of rampant speculation which falsely builds up the value of any market. When a market is then faced with stagnation or a correction, investors panic and begin selling off their shares or running on banks for cash. This cycle has repeated itself time and time again and shows no sign of stopping despite the numerous examples of markets failures and warning signs. This most recent crash again offers the opportunity to learn and stop repeating the same mistakes which have plagued people and nations as long as markets have existed.

Resources

Vox: The Global Stock Market Crash, Explained

The Economist: The Causes and Consequences of China’s Market Crash

Reuters: Markets Rebound from China Slump, Strong U.S. Data Helps

The Bubble Bubble: Historic Stock Market Crashes, Bubbles & Financial Crises

History: The Great Depression

About News: Stock Market Crash of 2008

International Business Times: China Stock Market Crash Explained in 90 Sseconds

The Wall Street Journal: China to Flood Economy with Cash as Global Markets Lose Faith

USA Today: Stock Leaps

The Guardian: China’s “Black Monday” Sends Markets Reeling Across the Globe

CNN Money: Dow sets a 2-day Record, Finishes up 369 Points

Michael Sliwinski

Michael Sliwinski (@MoneyMike4289) is a 2011 graduate of Ohio University in Athens with a Bachelor’s in History, as well as a 2014 graduate of the University of Georgia with a Master’s in International Policy. In his free time he enjoys writing, reading, and outdoor activites, particularly basketball. Contact Michael at staff@LawStreetMedia.com.

The post Riding the Wave: The Tumultuous Global Stock Market appeared first on Law Street.

Recent shifts in the Chinese stock market make America’s subprime mortgage fiasco look run-of-the-mill. From January 2014 to June of this year the market rose 150 percent, but since mid-June, the Shanghai Composite Index has lost more than 30 percent of its value. In fact, the recent slide was only slowed through direct intervention from the Chinese government. Following the Chinese market plunge, a number of opinions regarding what the crash means have been expressed. The debate ranges from fears of a full-scale, 1920s-era depression mixed with a housing bubble, to a simple market correction. Read on to learn about China’s market, what it actually means, as well as what impacts it has had on China and the world economy.

The Chinese Stock Market

History

The Chinese stock market, known as the Shanghai Stock Exchange (SSE), was founded in 1990. The market is overseen by the Chinese Securities Regulatory Commission, which is essentially a Chinese version of the U.S. Securities and Exchange Commission. After its start, the SSE has risen above competing exchanges to become the dominant market in China. Its purpose, so far, has been to raise capital for companies, particularly those in the infrastructure and tech fields. The SSE’s current goal is to transform Shanghai into a leading financial center on par with New York and London.

Volatility

While the SSE’s recent crash has garnered headlines, it followed a huge upswing, meaning that despite the recent plunge in stock prices, the market is actually up this year. To accurately discuss the volatility of the market it must be divided into two parts: a rise and fall.

First was the rise. Since the beginning of 2014 to June 2015 the market’s value rose by 150 percent. In the first five-and-a-half months of this year alone, the value rose by nearly 50 percent. The rise in China led to the increased importance of its financial industry, at the expense of traditional manufacturing powerhouses. This was all part of the government’s plan, which hoped to transition to a more financially driven economy, as growth rates slowed and eventually fell below the 10 percent glory days. However, China’s plan for its stock market has a taken a significant hit.

The rise, of course, is followed by a fall, and that fall has been dramatic. In a single two-week span, the value of the market fell by 25 percent. To put it another way, in just two days the market lost 11 percent of its value, which in the United States would translate to a 2,000 point drop in the DOW. These recent losses can be attributed to investors who were in highly leveraged positions, meaning they accumulated much more debt than the equity that they held, leading them to sell when margin calls began. A margin call happens when a broker demands that an investor, who used margin to pay for his investment, put up more money or collateral to cover a potential loss. In other words, people were buying shares on the SSE in an effort to get rich quick. However, when the market began collapsing, many were forced to sell in order to cover margin calls, which led to plummeting stock prices and marketwide panic.  The following video explains the fall:

A Deeper Meaning?

Government Response

So what does the recent crash mean for China? The Chinese government did not wait to find out. Following the collapse, the government reduced regulations on margin buying, halted new IPOs, and encouraged several other efforts aimed at increasing stock sales. Additionally, it stopped trading on most stocks and put a moratorium on selling in place for six months for all large investors. Finally, it threatened individuals and groups known as short sellers–parties that make money when a stock price declines.

The results of all these efforts have been less than encouraging. Following the temporary ban on selling, the market began falling even further. This is a result of the market being reopened to a natural state where investors can sell when an investment looks bad, as much of the Shanghai market looks right now.

Should we be worried about the collapse?

In the best case scenario, the collapse was all just the result of panicked investors with little experience; they saw the value of their investments grow rapidly and were anxious to cash out before anything bad happened. On the other hand, it is possible that the market was experiencing a bubble. A bubble occurs when something is overvalued because of continuous investing and not actual results, or because of the influx of a new product that projects future growth–think housing or tech in the United States.

Unfortunately, if the latter is true things could get worse before they get better. Because the Chinese government prevented the bubble from completely bursting, it could essentially be lingering there, waiting to burst when the regulations ease up. Even if this is not the case, the perception of a bubble could lower stock prices and companies’ desire to invest. Corporations who invested, including foreign ones, are also barred from selling right now and this episode may make them less likely to invest in China going forward.

Currently, the final outcome is still unclear and opinions remain divided. Some companies, such as Bank of America, Merrill Lynch, and Credit Suisse, see China as a systemic bubble that can or will burst when the government removes its support. On the other hand, Goldman Sachs sees the recent plunge as a market correction, needed to reduce over-valued stock prices and push out the wrong type of investors.  The video below details the crash and the government’s reaction:

The Impact

Because China has the number two economy in the world, a stock market crash is likely to have an effect that will reverberate around the world. So, what exactly does the stock market crash mean?

China

It may be too soon to understand how the recent plunge will affect China’s economy in the long run. While the market lost nearly $3.5 trillion since mid-June, its value remains positive this year due to a massive upswing early on. It is also difficult to tell whether the recent volatility will continue or if the market will start to settle down.

What the crash shows most clearly, though, is the oversized role of the government in economics and the unclear nature of its actions. The government’s response, which involved a significant amount of intervention from regulators, may discourage future investment. That response and the apparent lack of regulatory coordination indicate that the Chinese government have many worrying that it will run into further challenges as it attempts to balance stability with a more market-driven system.

Worldwide

The international impact of the Chinese market collapse has been less noticeable than the effect on China itself. Since China remains relatively isolated from the global financial system, the effect of the losses has had little impact on other markets. In fact, the stock market crash in China had considerably less influence on the world economy than tiny Greece–simply because Greece was more plugged in.

The real significance, if anything, will come in the future. If China’s economy takes a nose dive it could mean less investment coming from the country as well as fewer opportunities to invest in its markets. Additionally, efforts to further incorporate China into the world system may be scuttled. The video below discusses the ramifications of the Chinese stock market crash:

Conclusion

Seeing the Chinese stock market lose 25 to 30 percent of its value in about a month is very unsettling, especially with the recent Greek crisis and the lingering memory of the United States’ 2008 meltdown. But it is important to note that despite all the panic, the Shanghai index remains positive this year.

The real impact of the crash focuses primarily on China itself. For the average investor,  the collapse could have wiped out a lifetime worth of income, and may be the first sign of a lingering bubble in the market. For China’s general population, the crash revealed, much like in developed nations, the growing gap between haves and have-nots. For the have-nots, the fiasco may also slow promised social reforms, which could further exacerbate the wealth gap.

Ultimately for China, the crash presents yet another crossroad. The stock market was supposed to be the avenue for future growth when the country’s manufacturing sector fizzles, as it did in the earlier Western model. But the crash raises doubt. If China ever truly wants to be a global economic actor or at least a regional one, it will have to learn to manage volatility without excessive intervention and control from the government.

Resources

Primary

Shanghai Stock Exchange: Brief Introduction

Additional

Business Insider: Goldman Sach’s on China’s Stock Market collapse

Fortune: China’s Wild Stock Market Ride in One Chart

Bloomberg View: China’s Tamed Stock Market Might Bite its Economy

The New York Times: Cooling of China’s Stock Market Dents Major Driver of Economic Growth

Business Insider: Here’s a Simple Explanation of Why Chinese Stock Markets are in Free Fall Right Now

Slate: China’s Stock Market is Falling Again

Business Insider: China Pays a Price to Avert Stock Market Crash

The Washington Times: No Worries about Impact of China Stock Market Crash on U.S. Economy Yet

Michael Sliwinski

Michael Sliwinski (@MoneyMike4289) is a 2011 graduate of Ohio University in Athens with a Bachelor’s in History, as well as a 2014 graduate of the University of Georgia with a Master’s in International Policy. In his free time he enjoys writing, reading, and outdoor activites, particularly basketball. Contact Michael at staff@LawStreetMedia.com.

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