Many major markets lost between 4-5% of their value last week. Shanghai lost 9% in a day, starting the ripple. There was fear the government was going to reign in speculation that drove up that market over 200% in a year. Makes me want to know exactly what governing body decides Chinese economic policy. I doubt anyone outside of China truly knows, and the Chinese themselves might not know. This leads to questions of collective action. It can't be one person, just as markets are not moved by one investor - no matter how rich.
I'd like to devolve into a discussion of the bond vs. stock market, but all my understandings are too vulgar and easy to pick at despite whatever valid points I might make.
Instead, I'll simply point to aggregate action in the market and its irrationality. In theory if all investors acted pefectly rationally there would be no rise or fall in stock prices - all outcomes would be determinable and the profit expected by any particular company would be a given. Relaxing this we can either introduce irrationally driven investment strategies or bounded rationality, or a combination of the both. Bounded rationality is simple - we can't know all outcomes perfectly because we have imperfect information. Strict irrationality, however, is more complicated as its asymmetrical investment strategies often create the bubbles of speculation which tend to destabilize the market. Eventually all bubbles burst, and someone loses and maybe a few people win, but there comes the question of truly causal financial collapse within and across markets versus simple fear. Fear is obviously an irrational investment strategy, perhaps driven a bit by bounded rationality, but certainly tends to dominate or seed the collective behavior of market collapse.
Thus, Chinese fear may be driven the Chinese collapse, but to what extent and how was this investment behavior and devaluation causally determining further world collapse. There will always be rather mechanistic determinations of this equation, literally as certain as a computer-run algorithm, but then such collective market action becomes unstoppable if we are truly so linked to China now. The more interesting aspect is the proliferation of subjective beliefs concerning foreign markets and their impact on investment decisions. It would be very useful to know to what extent there exists an irrational motivation to the domino collapse of markets across the globe. Only when such a motivation makes up a certain significant proportion of market action will it even be possible to avoid this outcome.
That said, I write all this because I'm curious as to what will happen on the NYSE today. Japan slid over 3% already today, FTSE and DAX are both opening distinctly lower. Japan's slide was supposedly due to a surprising drop in the dollar. If people are not careful this could run away, even if markets attempt to throttle trading. At the same time, it's possible that a weaker dollar will strengthen our own position since it actually decreases the value of foreign held debt. In the end, I expect that at some point traders across the world will themselves spontaneously attempt to support the market.
As the Crash of 1929 was unfolding on Wall St. there were some very unusual heroics. Financial moguls actually met and attempted to collectively hold back the fear of millions of investors, sinking vast sums into worthless stocks in order to recreate market confidence. It was too late though, and they failed. In 1909 the strategy had worked. The question becomes at what point do investors collectively yet independently recognize when this strategy is required. It does happen from time to time, still. The ironic thing about this is that such behavior is, in fact, collectively rational yet independently realized price-fixing.