Cartoon: "Wall Street bubbles – Always the same." Puck (magazine) 1901. American financier J. P. Morgan is depicted as a bull, blowing soap bubbles for eager investors.
In the old days of the Chinese Cultural Revolution those who said or did something perceived by the Chinese authorities to be counter-revolutionary were forced into public confessions–and then humiliated, imprisoned or even put to death.
It seems that old ways die hard. Last week the new China–the one that had thrown off the yoke of the Cultural Revolution–televised forced confessions by people who dared to say that the Chinese stock market may not be a great place to put your money these days.
In addition, Chinese government officials are cracking down on short sellers–those who borrow stock to sell, hoping to buy it back at a lower price. Officials are prohibiting large holders of stock from selling for six months, and they are flooding brokerages with easy credit to encourage those brokerages and their clients to buy stocks with borrowed money. Who would have guessed that still nominally communist China would go to such great lengths to protect the most prominent symbol of out-of-control capitalism, a stock market bubble?
It seems that the government has forgotten the essence of a marketplace of stocks, namely, that for every buyer there must a seller. When those wishing to sell shares are denied the opportunity, they are likely to become increasingly doubtful that the denial is for their own good. The whole point of a stock market is to lessen the risk of investing in a company by making it possible to sell one’s shares at a moment’s notice when the need for cash or the opportunity for a better investment arises.
Marketplaces for investments are inherently unstable. The participants react to constantly changing conditions and perceptions. If markets were entirely predictable and transparent, there would be very little money to be made since everyone’s perception of the risks they were taking and the rewards they might reap would be identical.
But it is precisely the differences in perceptions (and personal or institutional needs) that create the desire to buy and sell. Unsophisticated individual investors (who make up the bulk of investors in China) were propagandized by the Chinese government to put their savings into the stock market. The government hoped the market would provide a cheap form of finance for Chinese industry.
Elsewhere in the world, we have the brokerage industry to propagandize individual investors with a message designed to convince them that despite its dips and troughs, stock market investing is a one-way street to prosperity. Those who keep buying–the story and the stocks–forget that those who are selling think that the stocks they are selling will go down.
With another swoon in stock prices mercifully interrupted in the United States by the Labor Day weekend, it is a supreme irony that many Americans will be spending their idle time worrying about the kind of wealth that does not come from their own labor. I have no doubt that many of them will be on their computers checking to see how the Shanghai Stock Exchange trades while they are forced to sit helplessly on Monday (a market holiday in the United States) and merely watch.
My father’s been asking me why what is happening in the Chinese stock market is of any importance to those outside the country. When the Chinese market started to plummet earlier in the summer, the move seemed to have little effect on markets in the United States and Europe (though attentive investors noticed that emerging stock market shares were also plunging.)
But we learned in the last stock market crash (and in recent weeks) that–to paraphrase the Coca-Cola jingle–the world’s financial system sings in perfect harmony. It is a complex, tightly networked system through which signals both benign and malign travel literally at the speed of light through wires and satellites. Those signals come from a world economy more closely connected into one great global system than ever before.
No one can really comprehend this system, and so no one can truly fix it when things go wrong. What is telling is that in the post-Communist age, we are supposed to be celebrating the triumph of the free market as an efficient, self-correcting mechanism that requires minimal oversight. But when that system corrects in ways that we don’t like, governments and regulators rush to prevent the correction without really knowing what they are doing.
The complex system of financial markets we’ve created and then tied all together electronically has become subject to increasingly frequent bouts of chaos that our financial models tell us cannot happen. It now ought to be clear that the mathematical models by which major banks and other financial institutions manage their risks are badly flawed. We get this declaration from none other than the world’s most prominent banker, Jamie Dimon, CEO of the banking colossus JPMorgan Chase & Co., who told the world that his models showed that an unusual move in U.S. Treasury bond rates last fall should only occur once every 3 billion years.
Dimon thought he was warning the U.S. government that its new banking regulations were setting the bond market up for a crisis in the future. Maybe so. But he was also unwittingly admitting that those managing our financial system don’t have a clue about the risks they are taking (usually with other people’s money).
If those who run the financial system don’t understand the risks they are taking, why should we listen to their advice concerning our own financial affairs?
As the worldwide stock market bubble deflates, people will increasingly take matters into their own hands. Buy-and-hold strategies will crumble in the face of stinging losses. Investors will come to realize that there is no inherent value in the paper claims on businesses that we call stocks–only the price that other people are willing to pay. It turns out that investing in the stock market is really a financial game of chicken.
Financial analysts and advisors will defend themselves by saying, "No one could have seen it coming." And according to their models, financial crashes of the type we experienced in 2008 are so rare that they are unlikely to occur anytime during the life of the planet.
The illusion that we can control the world financial system is just one more illusion we share in an increasingly unstable world. Once that illusion is shattered, we will have to rethink carefully our assumptions about our lives, financial and otherwise.
Cartoon: "Wall Street bubbles – Always the same." Puck (magazine) 1901. American financier J. P. Morgan is depicted as a bull, blowing soap bubbles for eager investors. (See Bull market.) Several of the bubbles are labeled, "Inflated values." Seen behind Morgan is a stock ticker, a machine which provided current information on stock prices. Via Wikimedia Commons.
