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'Irrational exuberance', Alan Greenspan and the Chinese stock market
by Adam Smith, the Eye Opener's economic expert

01-Jun-07 - """"It is rumoured that last week the former chair of America's Federal Reserve Board, Alan Greenspan, called the level of China's Shanghai Stock Exchange "clearly unsustainable".

Greenspan's warning doesn't carry the punch it once did. On Black Thursday, October 19, 1987, the Dow Jones average fell 22.6 % but, swiftly, a newly appointed Greenspan poured money into the American economy. The market recovered and the economy grew and grew and Greenspan became a legend. Many so called "analysts" specialized in predicting Greenspan's predictions. Predictions shielded in a vague econospeak Greenspan deliberately designed, if events proved them wrong, to take he and the analysts off the hook. Regardless, the Federal Reserve Board controls American interest rates and the American money supply. If a chair raises interest rates by 1 %, the stock market sinks by 7%. Vice versa - 1% down produces 7% up. Greenspan, a respected but rather right wing economist carried only two bottles of pills in his medicine kit - if the economy, production, employment, cools - to avoid a depression - lower interest rates and pump money in - if the economy overheats - to avoid inflation - increase rates and pull money out. When a Fed chair lowers rates and pumps money in, politicians love him. But they quickly resent any chair who trys to brake an overhated economy. That takes courage - there the rubber hits the road. In the later 1990s Americans, flush with too much money, used it to speculate in the stock market - starting a "speculative frenzy" fueled by what Greenspan, in 1996, publicly called "irrational exuberance" - it was time to raise interest rates and reduce the money supply. But master manipulator President Bill Clinton pressured a very political Greenspan and Greenspan buckled, did not raise the rates, talked no more of "irrational exuberance". The market rocketed and rocketed into the "dot-com bubble" which finally burst in 2001 - Americans lost seven trillion dollars in savings. Wary of the stock market - with good reason - Americans took to speculating in the prices of their own houses. A courageous chair would have dampened "the housing bubble" by pulling money out of the economy and increasing interest rates. On the contrary, pressured by the Bush Jr. administration, Greenspan again buckled and allowed the "Federal Funds" interest rate to sink to 1% (versus 6 % when Greenspan took office as Chair of the Fed and 18% in the 1980s). Greenspan actually cheered the bubble on and the housing bubble also burst (in February 2007).

The rulers of China also lack courage. The price earnings ratio (P/E ratio) measures the level of share prices by calculating the number of years it takes earnings from a share to repay an investor what he/she has paid for the share - the higher the P/E ratio the more expensive, in real terms, is the share. The P/E ratio of an average share bought in American stock markets at the height of the dot-com bubble was 38 (the average P/E ratio from 1946 to 1996 was 14 and when Greenspan took office was 23). The P/E ratio of an average share bought in the Shanghai market today is nearly 60. The average price of a share on the Chinese market is more than 250% higher than it was 18 months ago. China's rulers fear, irrationally, that, if they dampen down their stock market, they, the exuberant hosts of the 2008 Summer Olympics, may lose face.

  • About economic bubbles CLICK HERE
  • See Brian Milner's story in Saturday's Globe by CLICKING HERE.
  • See Wikipedia's article on dot com bubble by CLICKING HERE
  • For information about the Shanghai Stock Exchange CLICK HERE
  • For more information about Alan GreenspanCLICK HERE and have a look at Australian reporter, Peter Hartcher's excellent book on Greenspan, Bubble Man: Alan Greenspan and the Missing 7 Trillion Dollars for more information aboutBubble Man CLICK HERE
  • For more information about the Federal Reserve Board CLICK HERE; monetary policy CLICK HERE and the Federal Funds Rate and it's history CLICK HERE
  • For more information about the U.S. housing bubble CLICK HERE
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