When a stock market crashes

Crash is a common feature of stock market itself. There is no notable stock market in the world that did not crash at one time or another. 'Black Monday' like that of October 19, 1987 does often hit the stock market. But that is not the end of the world as the market picks up soon and carries on its business as usual. The recent Black Monday - the day stock markets lost 4.0-8.0 per cent in value on August 24 - will also be  forgotten very soon. The markets crashed all over the world as it was said to have been triggered by the crash in the Chinese stock market index.

The Chinese market was an overwhelmingly over-valued one where bubbles were building up since long. But the danger hidden behind the ever-shinning stock market was not perceived properly by the Chinese policy-makers. The correction started since June and when a big single day correction, which was a much-waited one, happened, the Chinese government was taken aback and it came up with a series of supportive measures in the face of big discontent of the Chinese retail investors. The Chinese stock market was relatively a new one as it started operation only in the beginning of 1990s when the Chinese economy was opened up fully for market operation and foreign participation. But the market expanded quickly and attracted many foreign investors also side by side with millions of local investors. Many people became unimaginably rich by investing in the Chinese stock market.

In fact, the Chinese stock market became the breeding ground for making stock investors rich. Initially, there were some restrictions on the foreign portfolio investors; they were not allowed to invest in all types of stocks and some stocks were kept reserved for the Chinese investors only. But a few years ago, that restriction was withdrawn. Now the Chinese stock market is equally open to foreign investors also. In fact, the global investors are the same people and institutions who and which invest in the world's stock markets, mostly through fund managers. These global investors are in a unique position to choose from variety of options unlike the local stock investors.

The Chinese stock market for many years moved only to one direction; that direction was up and up, in tandem with the Chinese economy which was moving ahead with a 10 - 11 per cent growth rate per annum (p.a.), turning the economy into the number one in the world within a period shorter than many people expected. Many Chinese stock investors started believing that investing in stock market is the only way to get rich quickly. The huge rush of investors to the stock market investment built bubbles in the market over the years. Intriguingly, this went unnoticed by the policy-makers. But everything has a limit; the market build-up also has a limit. After a point, it is bound to fall. A big fall is called a crash in the stock market literature. The Chinese stock market witnessed many small crashes since June of this year; only thing was that those crashes did not give any jolt to the other stock markets of the world. So long as the fall in the Shanghai stock market did not send a shivering effect to the investors of the other leading stock markets of the world, things seemed to be alright. But the August 24 Black Monday on the Shanghai stock market sent out a wave of panic and despair among investors of the global stock markets. That resulted in crashes of the world's leading markets on a much bigger scale than most of the experts could have believed. Global stock markets are interlinked. A fall in one leading stock market leads to fall in other stock markets; only scale of such a fall only differs. When does a stock market crash? It happens when a market experiences a continuous bull-run and reach to an unbelievingly high level. Bull-runs do not listen to any rational logic. Investors become intoxicated with greed and they follow the herd.

The Chinese investors did not notice that their economy already went out of steam and their stock market already became de-linked from their economy. When stock market becomes disconnected from the real economy and still continues building up bubbles, then danger becomes imminent. All over the world whenever a stock market crashed, it was found that stock price rose so high that it did not have any support from the real economy. In such a situation, the investors who lose most are the late entrants to the market. In the Chinese case also, the late entrants were the worst losers.

The Chinese government tried to do its best to keep its stock market index high. The government was under tremendous pressure from millions of Chinese retail investors who were made to believe that stock prices would only go up. In a run-up to save the market from further decline, the Chinese government stopped selling IPOs (initial public offerings) and share sales by the big investors and made margin loan availability easy with a lower interest rate. But those measures gave a respite to the market only temporarily; what had to happen happened: market crashed in the following few days. After the rout, the Chinese government started hunting for the perpetrators behind the crash. Already some big brokers and big investors were caught for bringing them to justice. Maybe some so-called masterminds behind August 24 Black Monday will be jailed, but that will not give back the money lost by the millions of investors. In fact, hunting for the perpetrators had been the common practice throughout the world in the aftermath of market crashes, but that did not prevent repetition of the history. Crashes happened again and again. In 1929, there was a big stock market crash in the New York stock market; that crash was followed by a prolonged economic depression which later became known as 'Great Depression'. Now also, concerned quarters apprehend whether the world economy will again enter a cycle of recession and from there to a depression.

The writer is Professor of Economics, University of Dhaka. abuahmedecon@yahoo.com