Tuesday, February 27, 2007

Shades of the 1990's Taiex in the Chinese stock correction of 2007

At the Computerworld newsroom this afternoon, we all followed the news coming out of Wall Street. The tumble in the Chinese markets led to a 400+ drop in the Dow. Our focus was on U.S. technology stocks and the impact of computer trading, but I was thinking back to major drops in the Taiwan stock exchange in the 1990s, when I lived and worked in Taipei.

Then, a lot of ordinary people had big investments in the Taiex, and there wasn't much sophistication about what they were buying or selling. Few retail investors paid attention to fundamentals, or invested in less risky investments like mutual funds. To millions of people, investing in securities was all about taking a gamble on stocks that TV gurus and friends recommended. People listened to these strategies, rumors, and supposed breakouts, and pumped more money in the runup. More often than not, they got seriously burned when the inevitable corrections took place. I know two people who played the market like it was a casino and lost lots of New Taiwan Dollars, especially after the Asian financial crisis of 1997, and a string of fradulent transactions carried out by executives at Taiwanese banks and investment companies led to panic in Taiwan's financial sector.

So earlier this year, when I heard about some of the risky investing behavior taking place among mainland Chinese investors, it reminded me of some of the irresponsible investing activities taking place in Taiwan ten years earlier. Chinese people love to gamble. It's a part of Chinese society. When this tendency carries over to investments, local real estate and stock markets can rise to spectacular heights -- and fall hard when the herd heads for the exits. We've seen it happen in Taiwan and Hong Kong in the 1990s and early part of this decade, and now we see it happening in China.

And, if Taiwan and Hong Kong are any guide, what we saw today in Shenzen and Shanghai is the start of a long-term cycle of heady rises and sharp corrections in mainland Chinese stock markets. The government in Beijing is making noises about reining in risky investment behavior, but I'm not convinced such measures will solve the problem. While limited controls -- such as those instituted by Taiwan in the 1990s, to halt trading in a stock if it moved 7% in either direction during the day -- may help limit the pain of panicked selloffs, they can't stop gamblers from entering the stock market casino.

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