Recent stock market volatility ‘not a crisis’

Katie Wade

The United States stock market suffered a crash the morning of Aug. 24 with the Dow Jones industrial average dropping as much as 1,089 points after the open and closing with a 588-point decline according to CNN.

Rob Weigand, professor of finance and Brenneman professor of business strategy, said that a combination of events in the global economy led to the drop in U.S. stocks that occurred Monday morning.

“Everything is so sensitively connected,” Weigand said. “You multiply Chinese shenanigans, nervous Eurozone, deflation in Japan and things slowing a little bit in the United States…that it’s like a nonlinear system.”

The straw that broke the camel’s back, according to Weigand, was the 8.5% drop in Chinese stocks that occurred overnight and resulted in the need for a correction on the U.S. side the following morning.

On Wall Street, program trades controlled by algorithms reacted to the severe decline in China and drove stocks down almost 10 percent at the open. About 20 minutes later, money managers began to intervene, implementing corrections so U.S. stocks would not be as severely affected by the changes in China.

“China’s problem is the overvaluation of their stocks and overbuilding these unproductive assets that they’ve put into place,” Weigand said.

While in the U.S., the market determines what is and is not valuable, in a system like China’s, the economy is closely governed and the government controls investments. China may sometimes invest in what are referred to as ‘cities to nowhere,’ in which cities are established that use natural resources, but no people or businesses exist there to make profits and pay taxes.

“These unproductive investments are weighing on China,” Weigand said. “They have thus started doing banking shenanigans, and other hard-handed government moves like abruptly devaluing their currency, which sends shockwaves throughout the world.”

Those shockwaves affect the value of stocks and resources of other countries in the global market. As Weigand explained, if China’s stocks and resources devalue by 20 percent, then suddenly the stocks and resources of a country like Brazil look 20 percent more expensive to global investors. In a country already on rocky ground economically, that shock would guarantee recession in Brazil just based on the one decision in China.

In reaction to the 8.5 percent drop, the People’s Bank of China, China’s central bank, made the decision to decrease the value of currency, the Chinese Yuan Renminbi (RMB), from 6.2 RMB/1 dollar to 6.4 RMB/1 dollar in an attempt to make Chinese commodities less expensive for consumers.

Tao “Tony” Wang, an exchange student from China who is currently working on his master’s degree in business administration, believes there are several reasons behind China’s attempt at increasing the fluidity of currency.

“As far as I know there are two reasons: the Chinese economics and the stock market,” Wang said. “And another reason, I would guess, is political.”

Though Wang says he lost money due to the change, he expects the Chinese economy to take a positive turn in the near future.

“It all depends on the economics of China,” Wang said. “For a short time I think the value of the RMB will continue down, but then it will rise up again. If the stock market begins to stabilize, the value of the RMB will also stabilize.”

In the U.S., stocks like Facebook and Apple went down significantly, which caused intraday volatility as investors rushed in to catch those bargains, bringing the prices back up with the buying pressure. A new wave of sellers then saw the potential to sell those stocks at higher prices later, resulting in big swings throughout the day.

According to Weigand, the major short term effect is a decline in spending.

“70 percent of our GDP [gross domestic product], the wealth that we make in a year, is driven by consumer spending,” Weigand said. “So if stock market type investors are pulling back on their spending…there can be a shockwave and market decline into GDP if the consumer gets scared.”

Corrections made in situations like Monday’s are a completely normal part of the stock market process. Though they usually occur every 14-15 months, the U.S. has not had one in over four years, one of the longest stretches on record.

“Stock market corrections help reset valuations to saner levels,” Weigand said. “We’re just not conditioned to the abrupt declines that can occur.”

On Monday, the hashtag ‘Black Monday’ was trending on Twitter describing the global market concerns. As of Tuesday afternoon Aug. 25, the Dow closed with a 204-point decline. Other markets around the globe also seemed to be recovering, or at least stabilizing. China, however, was not out of the woods yet, with government agencies considering intervention, according to The Guardian.

To those nervous about the decline that occurred, Weigand reminds us that this is definitely not the same crisis that occurred in 2008.

“There’s not a huge unraveling of credit or the banking system freezing up,” Weigand said. “It’s not a financial crisis – it’s a correction.”