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Monday, August 10, 2015, 10:47

Stock market volatility is normal

By Giles Chance

Government should focus on setting fair rules and make sure they are followed.

Stock market volatility is normal

When I became involved with China, in the late 1980s, Western media coverage of the country was small, and was aimed largely at Sinophiles with an interest in Chinese history. Naturally, the past 25 years have witnessed a tremendous increase in worldwide interest in China, as the country has risen to economic superpower status. But most of the new media coverage has not been accompanied by a corresponding increase in understanding. Almost every day, one can read columns and watch programs that seem to refer to China as if the country were on another planet.

Since 2014, international media coverage has focused increasingly on the volatile performance of the Chinese mainland's two stock markets, in Shanghai and Shenzhen, which rose between July 15, 2014 and June 12, 2015 by 150 percent in Shanghai and 185 percent in Shenzhen. They then fell in Shanghai over the next 21 days by 29 percent, and by 40 percent in Shenzhen, before recovering to close on July 15 this year, up 3 percent and 9 percent respectively, from the June low.

The behavior of the Chinese stock market seems to be more like a casino in Macao than a respected and important financial institution. Much of the media comment has perceived this extreme market volatility as another straw in the wind signaling the long-awaited China crash. Does the behavior of China's stock markets really mean this?

In October 1987, I was working as a fund manager based in London, responsible (with my colleagues) for several billion dollars' worth of investments denominated in major international currencies. Oct 19, 1987, a day known as Black Monday, is a date that no one working in the market at that time will forget. The US stock market fell by about 25 percent in the morning. This puts the recent volatility in Chinese markets into context. The dollar collapsed in value. Bond markets soared, as investors rushed from risky equities to the relative safety of debt obligations issued by the US government. Riskier stock markets in emerging economies were hit hard. The losses on the Hong Kong stock market were so large that the market closed for a week. Investors in Hong Kong stocks were unable to trade, and suffered severe losses when the market eventually reopened.

But by January 1988, the stock market in New York had started to recover and confidence began to flood back, as investors began to worry more about missing out on rising prices than about losing money as prices fell.

The reason for Black Monday in 1987 was that, after a long period of economic expansion, consumer price inflation had started to rise. In February 1987, the Federal Reserve under Alan Greenspan had started to tighten monetary policy to contain consumer price increases. Financial securities, which are denominated in money, are highly sensitive to the cost and supply of money, and therefore to changes in interest rates.

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