CHI/MERICAN Chaos in the Markets

CHAOS THEORY proposes that, by merely flapping its wings in the Amazonian jungle, a single butterfly can cause a hurricane in Manhattan. Something similar can be said of financial markets, as we saw last week. The butterfly in this case was the fledgling Shanghai stock market. When Chinese investors flapped on Tuesday, the result was a storm in nearly all of the world's stock markets. No fewer than 45 of 53 major stock markets ended the month below where they had started.By the end of the week, however, skeptical commentators were questioning the chaos theory version of events. How could a stock exchange with a market capitalization barely 5% the size of New York's possibly be responsible for such international turmoil? There had to be some other reason. Maybe former Alan Greenspan's use of the word "recession" in an interview? Guys, please. He retired as Fed chairman more than a year ago.Actually, you don't need chaos theory to explain this; economics does the job pretty well. What we witnessed last week was a symptom of a deeper structural shift in the balance of global economic power. Ask yourself why last year was such a remarkable year in financial markets; why nearly every stock market ended the year at a record high; why there seemed to be no limit to the money to be made by investment banks, hedge funds and private equity groups. Some analysts say it was excessive liquidity. Others talk of a shortage of assets. But the most compelling answer is the seismic effect of China's entry into the global economy. It has been the effect of China's vast, cheap labor force on global wage levels that has driven up U.S. corporate profits from about 7% of gross domestic product in 2001 to 12% last year. At the same time, the flood of Chinese savings into the global capital market has driven down global long-term real interest rates from about 5% seven years ago to 2.8% last year.

................and it goes on in the LATimes in an op-ed piece by Niall Ferguson.