History tells there have been two types of bubble. There’s the bubble when madness and greed beget a child. And then there’s that which is born of reason, but finds itself adopted by the parents of its more insidious rival.
The South Sea and Tulip bubbles of bygone years clearly fall into the former category. The 1929 crash, which was followed by a very nasty economic depression in the US, did at least start from a level of rationality. The decade that preceded that dark period did see remarkable advances in manufacturing – not to mention the revolution that was the motor car – but too much hope, too much expectation, and too much irrationality created an economy that had grown at an unsustainable rate, and a stock market that exceeded any kind of rational expectation.
Then there was the dot.com bubble. Again, there was some reason behind the madness. Recent experience has, after all, shown the internet could indeed change the world. It’s just that when greed and madness get hold of a good idea, it can be twisted and pulled into a shape that is unrecognisable from reality – often tarnishing the good ideas and the business plans that really were well thought through and perfect for exploiting the new medium. It left only the inspired, such as the people who chose to back Google during this chaotic era, seeing the reason behind the insanity.
But then you have falls that turn out not to be a bursting bubble at all. They are merely corrections. Maybe the stock market crash of 1987 was such an animal; after all, it took very little time before indices were once again passing the ’87 peaks
The question then is this: which one did we see yesterday? And who knows, by the time you read this, which one are we seeing today?
Maybe the answer is both.
Maybe in China we are seeing a correction. The economy has grown at an unprecedented rate, but (assuming US paranoia does not enforce a period of self-destructive barriers to trade, throwing the world into recession), this is set to continue – albeit at a less exponential rate. Yesterday’s falls were little more than the market seeing reason creep in, and an adjustment as markets discount some of the overexcitement.
But remember, the Chinese stock market is tiny in comparison to the markets in the US, Japan, and UK. It’s a minnow. In such small markets volatility is often much greater, and both swings up and down can be more dramatic than usual.
Is it really rational for the giant markets of the US, UK and Japan to react the way they did yesterday, just because China saw a correction?
The danger is this: while China sees little more than a correction, in the west we are witnessing the beginning of a bursting of a very unpleasant bubble indeed.
This bubble is a cousin to the dot.com and stock market crash seen earlier this decade, but its parents are not the same.
This bubble was created as central banks across the globe reacted to the troubles of irrational exuberant ’90s buying, of fear created by 9/11, and the paranoia of financial scandals that brought down Enron and Worldcom, by pumping money into the world, and by slashing the rate of interest.
And thanks to China, the internet, and all the other forces of globalisation creating a deflationary environment, we were lulled into a false sense of security. Growth followed expansionary monetary policy as surely as day follows night, but inflation stayed coiled up in its prison, under the watchful eyes of wardens Eddie George and Alan Greenspan, and then Mervyn King and Ben Bernanke.
But if the economy is a vessel brimming over with liquid iron pyrites, and globalisation stops it from leaking out at the obvious point, it has to give somewhere else.
The danger is that in the US, yesterday, that’s what we started to witness. Could it be, that is when the great asset bubble of the noughties finally began to burst.
This analysis may, of course, be wrong. But, as we warned yesterday, as we live longer and the birth rate falls, coupled with the fact that pension funds no longer enjoy the meteoric growth they once did, we sit on a pension time bomb, ticking ever louder in our ears like an iPod playing the tune of no hope.
To counteract this impending disaster, we need to download the saving song. But then it’s been consumption, and the reckless buying of US and UK citizens and governments, while the relatively high rate of interest kept the dollar and pound too high and created massive balance of trade deficits, that has propped up the global economy in recent years.
Can we really solve the deeper underlying problem without causing a major global slowdown?
That brings us back to China. Our big hope lies beyond the Great Wall. Maybe the growth in developing economies can bail us out. And yet US senators look behind their shoulders at this growing economic power and see threat and menace, and the need to protect their local business.
Do you see why we fear that yesterday’s crashes in the US could spell so much more than just the whisper of a Chinese correction?
© Investment & Business News 2013