Stocks around the world followed China's Shanghai Composite index, which plunged in reaction to news that the government might crack down on the speculative trading that has driven up stock prices in China to record levels.
The Washington Post
SOURCE: Bloomberg News | The Washington Post - February 28, 2007
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Stock Sell-Off in China Hits Wall Street

Traders at the New York Stock Exchange had to contend with a rapidly falling Dow Jones industrial average, which ended down 416 points.
Traders at the New York Stock Exchange had to contend with a rapidly falling Dow Jones industrial average, which ended down 416 points. (By Daniel Acker -- Bloomberg News)

Moreover, investors fled emerging markets and took safe positions in the currencies of Japan and other countries where borrowing costs are among the lowest in the world. As emerging markets took it on the chin yesterday, the yen climbed 2.3 percent against the dollar, the most in nearly a year.

This occurred because investors sought to protect their money in case of a sustained downturn. In a growing global economy, these investors can take more risks and obtain higher returns by borrowing money and pouring it into emerging economies like China and India.

To many investors, yesterday's events were a stark demonstration of the vulnerabilities of the global economy, not just that of the United States. That a sell-off in China could have such serious reverberations around the world was noteworthy, said Joseph E. Stiglitz, a Nobel Prize winner and former chief economist at the World Bank.

"China has been the engine for global growth," Stiglitz said. "And a significant slowdown in China would have fundamental implications for commodity prices around the world. . . . Oil prices have been sustained by high Chinese demand. Just think of what would happen if there's a significant part of China that had a slowdown."

Analysts in China blamed yesterday's plunge, which at 9 percent was the largest single-day drop in a decade, on the news of a crackdown by the State Council, the Chinese cabinet, on illegal activities related to securities trading. According to a statement on the government's Web site, a special task force would be convened to provide recommendations for how to "repair" illegal securities activities.

On Wednesday morning, Chinese regulators denied rumors of plans for a 20 percent capital gains tax on stock investments, one factor that had sent markets lower.

China's stock markets began their surge upward in June 2006, after the government again allowed domestic initial public offerings after a long hiatus. There were a number of other securities milestones last year. The government took $200 billion of stock it owned and allowed it to be traded publicly. And several of the country's largest state-owned companies, including the Industrial and Commercial Bank of China, were dual-listed on the Shanghai and Hong Kong stock exchanges.

The Shanghai Stock Exchange rose 130 percent in 2006, and it was up 12 percent from Jan. 1 to mid-February. Just before the Chinese New Year holiday, the Shanghai Stock Exchange broke the 3,000-point mark for the first time.

Signs that China's two domestic stock markets, in Shanghai and Shenzhen, may be over-inflated began to show up in early February after Cheng Siwei, vice chairman of the Nation's People Congress, said publicly that he worried about a "bubble." The stock market fell 11 percent that week but quickly made up the losses and continued to hit new highs.

Then came China's Black Tuesday, which yesterday wiped out $100 billion of market value.

Feng Yu, a broker at China Galaxy Securities in the southeastern city of Ningbo, said he believed yesterday's drop was only a "technical correction" to make up for the unprecedented rise in recent months.

"At the beginning it was just banking stocks," Feng said. "Then it affected all shares," Feng said he believed the drop was precipitated by signals from the government that it wanted to slow down the explosive growth, which has prompted individual investors to line up for hours to open brokerage accounts.

Another piece of troubling news was released yesterday: The Commerce Department reported that durable-goods orders fell 7.8 percent in January, to a seasonally adjusted $204 billion. The decline, including in such large-order items as airplanes, semiconductors and appliances, surprised Wall Street, which had expected a 3.2 percent drop.

In Washington, the confluence of world economic events got the attention of the White House. "The president's economic advisers are paying attention to the markets," spokesman Tony Fratto said. "We continue to believe that the U.S. economy is sound."

The Federal Reserve, meanwhile, was silent, indicating that it did not view the market's drop as a threat to the abilities of U.S. financial firms to function.

This was in contrast to the Fed's response to the much sharper stock price declines of the October 1987 crash and after the Sept. 11, 2001, terrorist attacks, when the central bank issued statements reassuring the markets and investors that it would provide ample funds to the financial system to ensure transactions could be completed.

But analysts said Fed Chairman Ben S. Bernanke would probably be asked to comment on the global financial gyrations this morning when he is scheduled to testify before the House Budget Committee.

Correspondent Ariana Eunjung Cha in Shanghai, staff writer Nell Henderson and staff researcher Richard Drezen contributed to this report.

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