The US stock market had its worst ever initial trading week in 2016. Speculators are alarmed by the fall in the stocks of China. The economy of China has been growing more slowly, if at all. Also, most of the economies of the world are in growth recessions, a reduction in the rate of growth. The US dollar is high relative to other currencies, which reduces exports.

The government of China has yet to learn that interventions into financial markets often backfire. The Chinese chiefs have halted stock transactions when the market average falls to seven percent. They also have not allowed sales by investors who own more than five percent of a company. One problem with financial “circuit breakers” - a halt of trading - is that when stocks start to fall, speculators will panic and sell more quickly before trading halts. Restrictions on selling stocks create uncertainty when buying them. A speculator will fear being unable to sell shares later.

Uncertainty makes it important to let the market set the prices. Markets are a discovery process in which prices and quantities evolve through the bids of buyers and offers of sellers. When government interferes, we cannot know the real price.

There is enough inherent uncertainty in markets without government adding to it. Uncertainty makes it important to let the market set the prices. Markets are a discovery process in which prices and quantities evolve through the bids of buyers and offers of sellers. When government interferes, we cannot know the real price. Since the leaders of China have decided to have a market economy in goods, input factors, and financial assets, they should allow the market to do its job of setting the prices.

When I visited China three times, I saw a forest of cranes in all the cities I went to. Construction has driven the economy of China, along with exports. But, similar to real estate booms elsewhere, this construction was propelled by governmental policy. Throughout the world, cheap credit and fiscal subsidies to real estate have fueled unsustainable speculation.

Now China has much excess building capacity, and the halt in construction reduces related goods such as furniture and raw materials. The slow-down in China and sluggish growth elsewhere has resulted in a collapse of commodity prices.

The chiefs of China seek to move the country’s economy towards more domestic consumption. But they interfere with domestic spending by imposing a value-added tax of 17 percent on most goods other than real estate. The government of China probably chose to impose a VAT because the World Trade Organization allows the VAT to be subtracted from the price of exports, unlike an income tax. But Chinese consumers suffer a higher cost of living. The Chinese leaders could have instead enacted LVT, land-value taxation, which would not add to the cost of goods. A tax on land value reduces the purchase price but not the land rent, so also not the price of goods. A tax on most of the rent or land value would stop the land speculation that has made a few people rich at the expense of the public.

The chiefs of China seek to move the country’s economy towards more domestic consumption. But they interfere with domestic spending by imposing a value-added tax of 17 percent on most goods other than real estate. The government of China probably chose to impose a VAT because the World Trade Organization allows the VAT to be subtracted from the price of exports, unlike an income tax. But Chinese consumers suffer a higher cost of living.

The Chinese leaders could have instead enacted LVT, land-value taxation, which would not add to the cost of goods. A tax on land value reduces the purchase price but not the land rent, so also not the price of goods. A tax on most of the rent or land value would stop the land speculation that has made a few people rich at the expense of the public.

The government of China still maintains tight control over the banking system. All the markets—real estate, financial, goods—would be more efficient if interest rates too were set by the market supply and demand for loanable funds. Of course the central banks of Europe, Japan, and the USA also are not letting their markets set the money supply and interest rates. But common practice does not imply optimal policy.

For 200 years, the US economy has had a real estate cycle of an average duration of 18 years. The current cycle began with the depression of 2008. The recovery has been slow, but the expansion has continued as employment and output have grown. Real estate construction has contributed to the expansion, and land values have recovered. The economy seldom has a recession while interest rates and commodity prices are low.

I don’t think the big drop in stock market averages imply impending economic doom. For 200 years, the US economy has had a real estate cycle of an average duration of 18 years. The current cycle began with the depression of 2008. The recovery has been slow, but the expansion has continued as employment and output have grown. Real estate construction has contributed to the expansion, and land values have recovered. The economy seldom has a recession while interest rates and commodity prices are low.

The economy of China has some severe long-run problems, but its economy is still developing and catching up. The government seems ready to let the currency trade more freely, and the coming acceptance of the currency (the yuan or renminbi) into the “special drawing rights” of the International Monetary Fund will boost the economy.

What we should be worried about is the unsustainability of debt and the next real estate speculative boom. The next economic disaster is about a decade into the future, and nobody is yet alarmed about that.

In the short run, the US stock market could fall some more, as markets often overreach, but over the next few years, financial markets will be consistent with the economic reality of restored world-wide economic growth, if there are no major destructive attacks. What we should be worried about is the unsustainability of debt and the next real estate speculative boom. The next economic disaster is about a decade into the future, and nobody is yet alarmed about that.

© Text Copyright Fred Foldvary, Ph.D. rights reserved.
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