What role do market expectations play in financial crises? How are the expectations formed and how do they evolve? Figuring out answers to these questions could help countries better cope with crises going forward.
Some researchers have said that media coverage intensified and exacerbated risk contagion during the 1998 Asian financial crisis. Such a theory led to the “conclusion” that if information had been effectively blocked, banks involved in that crisis could have stopped panicking and the crisis could have been brought under control. However, this thought just reflects naivety shaped by the mentality of a planned economy. Andrew Sheng, a distinguished fellow at the University of Hong Kong, concluded that the crisis originated from the overseas expansion of Japanese capital after Japan’s economic bubble burst. Japanese capital’s subsequent withdrawal from Southeast Asian countries exposed shortcomings in their banking sector that their governments were incapable of managing, providing Western speculators with the opportunity to impact their monetary systems.
Fast forward a decade, the 2008 financial crisis in Europe and the U.S. was fundamentally a result of financial institutions lending mortgages to people who couldn’t repay, and selling products backed by the mortgages to financial institutions around the world. After a temporary boom, the value of the underlying assets plunged, and the risks associated with financial institutions using high leverage to invest in subprime mortgage-backed derivatives blew up and were passed on to financial institutions worldwide.
Both the Asian financial crisis and the subprime mortgage crisis exposed flaws in the economies: poor risk management of underlying assets, the high leverage which extraordinarily pumped up the risks, or the lack of effective financial supervision. To address these flaws, the market needs to be able to make informed decisions, and the regulators need to know what is truly happening in the market.
In a market economy, decisions are made by countless decentralized market entities based on the information, knowledge, experience, and business intuition they possess. For these entities, a lack of transparency could deepen a crisis of confidence. If information is inadequate or one-sided, the market could overreact. A market recovery from a crisis also requires effective communication from the government.
The negative impact of blocking information shouldn’t be taken too lightly, as doing so can expedite the creation and spread of rumors at a time when the bar for spreading information online is extremely low. The proliferation of false information can jeopardize the economy. An example in point is the Soviet-style planned economy, which achieved a high degree of uniformity across sectors and considerable economic success, but was ultimately destroyed by the falsification of information from top to bottom.
In China, the relationship between regulators and market entities is not equal. As a result, market entities may not always dare to tell the truth to regulatory authorities. One voice does not always mean one mind, especially when it comes to business judgments of market entities.
For a government to make science-based decisions, it badly needs massive amounts of honest and reliable information. To receive this, it needs to listen to the market. The market itself has a large number of information-generating entities. The information either contradicts or corroborates each other, but fake information can be continuously removed through investigation, research and examination by industry peers, financial institutions, research institutions and professional media. In turn, the government should release public information into the market, and let public information become an important part in market entities’ decision-making process. In other words, if the government wants to guide and manage market expectations, the core lies in communicating with the market through multiple channels, listening to the real thoughts of market players, finding ways to release accurate interpretations of policies, and even putting forward positive frameworks for interpreting policies. In this way, the government could effectively move the market.
The key to building a good socialist market economy is to have faith in the market, respect the market, and manage the relationship between the government and the market well. This was and still is true.
Ling Huawei is managing editor of Caixin Media and Caixin Weekly.
This article has been edited for length and clarity.
Contact translator Zhang Yukun (yukunzhang@caixin.com) and editor Heather Mowbray (heathermowbray@caixin.com)
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