This will not be the last post I make on the Shanghai stock exchange, but I thought I’d get ahead of things this morning and comment on yesterday’s drop in the stock market, which was almost 9%.

The papers today are full of speculation as to why this happened and what it means.  The Associated Press explains the drop:

Chinese stocks plunged nearly 9 percent Tuesday, their biggest drop in a decade, rattling markets from Hong Kong to Singapore and as far away as New York amid fears of a slowdown in China’s economy.

Investors were also spooked by comments Monday from former Federal Reserve Chairman Alan Greenspan, who said a recession in the U.S. was “possible” later this year.

CNN Money leads with this (a Reuters story):

Chinese stocks plunged nearly 9 percent Tuesday – the market’s worst drop in a decade – amid fears that authorities would crack down on speculation that drove shares to record highs. Traders said the slide, which wiped out about $140 billion of market value, did not appear to be triggered by concrete news.

So Wall Street panics and drops a few points, and other world markets have gone down as well. On all the talk shows today, the question will be whether this is a sign/evidence that China’s red-hot economy is going to tank in the near future?

Not surprisingly, but I think most of the speculation today will be stupid and off-base, at least from a lot of the mainstream Western broadcast media. Sensationalism will trump the real story, which is . . . this is called a ‘correction’ in a market that had been bid up too high. Wow, complicated, huh?

Seriously, the Shanghai exchange had hit an all-time high recently, and the stock market itself just emerged in 2006 from years of inactivity and inefficiencies, with the government halting any new listing for a period of time until management and policy caught up with reality. So is it really surprising that pent-up demand for new domestic securities, particularly some of the very impressive enterprises that have listed, bid up prices to the point where some were calling the situation a ‘bubble’? Not surprising at all, also considering that there is a real dearth of investment products that are available to domestic investors, both institutional and individual.

As to the specifics. Many commentators are attributing at least some of this to speculation that Beijing will institute new policies this year to slow down the economy. As far as the policies are concerned, this is undoubtedly true. How much this was responsible for the market correction is something else, however.  Beijing has been introducing such policies for the last couple of years, so none of this is really new. This week’s announcement of a rise in the reserve ratio came as no shock – this has been done before. Other measures designed to slow fixed asset investment are ongoing.  A slightly slower economy and more consumption are desirable, and everyone already knows this.

Other rumors on policies include crackdowns on corruption and illegal trading that might have an effect on the market (probably positive, in my mind), a new capital gains tax, etc.

Speculation on the timing is also interesting. On the one hand, you have the stock market itself hitting an all-time high recently, so profit-takers are out in force. On the other hand, for supporters of the “new policies” story, you have the National People’s Congress meeting here next week, which should include debate and/or passage of some important legislation, including tax measures and the new property law. I suppose the timing is too close to ignore it, but we have known about the NPC meeting for a while now, and the agenda has been circulated in advance as well. If there are any huge surprises in store for the NPC meeting, not too many folks have concrete details at this point.

So where does that leave us with the ‘doom-and-gloom’ stories that are out there right now? Well, I would say ignore them. We had a correction to an overly-hot market that was high for several reasons, some of which were unsustainable. This correction was not necessarily related to any underlying conditions in the Chinese economy (no shocking stats were revealed yesterday that triggered the sell-off), so things are the same now as they were a few days ago. If the economy here slows a point or two this year, that would in fact be a positive development.

Best comment I’ve seen so far is the following: “The most important reason for today’s decline was pressure for profit-taking.” This was from Peng Yunliang at Shanghai Securities, quoted in the AP story. Makes a lot more sense than wild rumors about new corporate taxes. It also means that the sky is not falling and that headlines like “Stocks plunge on fears about China and growth” are misleading at best and possibly irresponsible.

As to the speculation that ex-Fed Chairman Greenspan’s comments that a U.S. recession was possible later this year triggered the sell-off, this is sad. It is even more sad because there may be some truth in it, and this is another reason why I dislike writing about and dealing with the stock market. The psychological and “stupid” factors make commentary tricky. By the way, and for the record, here is what Greenspan actually said:

While, yes, it is possible we can get a recession in the latter months of 2007, most forecasters are not making that judgment and indeed are projecting forward into 2008 … with some slowdown.

Doesn’t sound like he is predicting a recession, but then again, why should folks actually have to listen to his full remarks instead of hearing insipid, and incorrect, commentary from some analyst on CNN?