Market turmoil: crash or correction?

The Shanghai composite index registered its biggest one-day fall in a decade this week, tumbling over 8% and sparking a world-wide sell-off. Was this just another example of the Shanghai market's renowned volatility - or something more serious?

MoneyWeek reported three weeks ago on fears that China's stockmarket had moved into bubble territory. The Shanghai Composite Index promptly powered even higher, breaking through 3,000 for the first time last Monday. But investors took fright just a day later, sending the index down 8.8%, its biggest one-day fall in a decade.

The plunge sparked a global sell-off. The Dow Jones ended Tuesday down a hefty 3.3%, shedding 416 points, while the FTSE 100 lost 2.3%, falling 148 points. At one point, the falls on Wall Street became so bad that the White House said it was "monitoring the situation", reported The Daily Telegraph.

Was this just the latest manifestation of the Shanghai market's renowned volatility, possibly triggered by news that the State Council is to curb speculation by clamping down on illegal share offerings and preventing banks from lending money to investors to buy shares? "People are just on edge," suggested one analyst. "It's very possible that in two weeks we'll be right back up there." And the Chinese government, which "can pull a lot of financial levers", has been warning of overheating after the market's 130% rise in a year, said Edward Hadas on Breakingviews, who put the knock-on impact down to jitters. "Enough traders were ready to take profits that the news from Shanghai could have triggered a small wave of selling."

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But David Fuller of Fullermoney was less sanguine, announcing the start of "a global stockmarket correction". He said he expected the slump to be less severe than that of last May, but noted "a degree of panic", particularly in the US, where a stockmarket slide is "the last thing [the country] can afford". Marc Faber, editor of The Gloom, Boom & Doom Report, was equally nervous: "I wouldn't buy in emerging markets," he told Bloomberg. "Something has changed in the financial market it's time to sell rallies rather than buy dips."

The Chinese sell-off came as doubts are being raised over the sustainability of China's economic growth rate, which hit 10.7% in 2006. The usual explanations for the blistering pace market forces unleashed on 1.3 billion frugal, hard-working people "do capture part of the story", said Jim Jubak on MSN Finance. But while the country isn't about to slip back into economic insignificance, the current situation has been built on "non-renewable human, environmental and capital resources". Once they've been mined for the easy gains, "China's rate of growth will fall back to something like normal'". What's happening in China today has more than a few parallels with Japan in the late 1980s, added Lawrence Summers in the FT. Then, easy monetary and financial policies created huge asset price bubbles and expansions in credit, setting the stage for the subsequent downturn.

But regardless of China's admittedly numerous problems including the commitment of its leaders to "another 100 years of socialism" the real threat to the global financial system does not lie to the East, said Martin Hutchinson on Breakingviews. "The global pool of capital has been seeking higher returns in recent years," with money pouring into risky assets "from US mortgages to Latin American debt. Central banks have raised rates some 90 times since the beginning of last year." Eventually, he says, this drying up in global liquidity "is likely to end in a crash. Just don't blame it on Asia".

Indeed, said Damian Reece in The Daily Telegraph: "Rather more worrying

is the recession building in the world's leading, fully formed capitalist system." Former Fed chief Alan Greenspan earlier this week warned that a US recession might arrive by the year end. House prices are collapsing, "we have already seen the dollar collapse" and now Wall Street is taking a tumble too. "Investors should be concerned less with a regular bout of financial Asian flu and more worried about a nasty case of Rocky Mountain Spotted Fever crossing the Atlantic."