Dr Steve McCabe, Birmingham City University Business School

Economists like to think that there are consistent pattern of behaviour in markets. However, ‘markets’ are simply a mechanism consisting of the aggregate behaviour of those who trade in whatever the relevant commodity is.

It’s important to remember that market behaviour is influenced by the basic human instincts of greed and fear This is what makes markets the less than perfect method by which to determine the value of commodities. Markets are inherently irrational though, I acknowledge, most of the time they are pretty stable.

However, events some eight years ago showed what happens when irrationality and fear collide. I am referring to the Global Financial Crisis (GFC) which caused consequences that still profoundly affect behaviour.

One general ‘law’ that economists like to believe has some degree of veracity is that of cycles of activity. In particular there is a belief that an economic cycle of activity consisting of the period between two peaks can follow a consistent pattern. However, as even cursory consultation of economic theory will show, there is no agreement on what the length is.

That stated, empirical evidence since the beginning of the last century suggests that economic cycles occur in ten to fifteen year cycles. And as the analysis of the GFC show, there are always warning signs of impending doom though, in 2007, the collapse was as rapid as it was spectacular.

Which brings me to events in China. The fact that Chinese stocks fell by over 8% in one day – the biggest one-day fall for more than eight years – would suggest that there are troubled times ahead and that we could be entering another global recession.

Indeed, the fact that reduced demand from the most dominant ‘emergent’ economy, China, after America is the world’s second largest, has caused a fall in commodity prices including gold, crude oil, aluminium, copper, iron and platinum would also indicate that things are becoming increasingly difficult.

That the price of Chinese stock fell by 30% in June created panic. However, as many analysts have been arguing for quite some time, the Chinese economy has been overheating for the last few years.

Moreover, it’s worth recalling that over the last 12 months investors in China have enjoyed spectacular gains prior to the recent falls; prior to the fall in June they had risen by 150%.

Over the long-term, it seems, you win and you lose. Or as ‘high-roller’ billion dollar investor Warren Buffet famously stated, “If you aren’t thinking about owning a stock for 10 years, don’t even think about owning it for 10 minutes.”

However, what is important is that China contributes 17% of the world’s GDP. Therefore, if what we are seeing are both declines in the value of the Chinese stock market and its demand for commodities of, most especially, oil, copper and iron there is reason to be concerned.

The harbingers of doom would suggest that all of this points to the beginnings of another GFC which, as far as the UK is concerned, is worrying as we are still recovering from the last one.

Therefore we may be seeing a short-term readjustment in the Chinese economy which, though painful for investors who bought at the top will settle down. The trouble is that China’s influence on the world economy is so crucial to mean that the current portents should make us very concerned.

One thing is for sure; just as the value of markets rise they also fall. In the long-term it all sorts itself out.

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Dr Steve McCabe

Dr Steve McCabe

Birmingham City Business School