Two days ago, Greek voters said “No” to the term of EU bailout in a national referendum. Yesterday, the Shanghai Stock Index fell another 5.9%. Cumulatively, the index has fallen 30+% since reaching its peak in June 12. Which of these two events will likely be the black swan that rocks the US market.

I don’t think it will be Greece. The Greek economy is a mere 1.7% of the total EU. It’s basically a rounding error. When the first act of this Greek drama was played in 2011, the US market promptly dropped 19%. That was a wealth destruction ten times the size of the entire Greek economy. This just shows the fear of a disaster can be much worse than than disaster itself. Now that we are in the third act of this Greek drama, global markets are more or less immune to it.

China is an entirely different matter, and it has a potential to become a black swan …

• The stock market crash there just vaporized $3 trillion worth of investor wealth, all within a month. 99% of those investors are domestic Chinese investors.
• According to a Goldman Sachs research, Chinese investors are highly leveraged. By some estimate, a 30% loss in market index could translate into a 60% loss to the average investor.
• The growth engine for the Chinese economy is domestic consumption, not export or investment any more. Domestic consumption has been growing 10% a year in the past few years, you bet it’s gonna be affected by the market crash.
• There are 90 million stock investors in China, larger than the entire communist party membership. They are panicking, fearful, resentful, restless. As they have been conditioned to believe in the party, now they are blaming the party for their losses. The specter of massive single issue social unrest can not be ruled out. China is the second largest economy in the world, should a massive unrest breakout, the effect will reverberate across the Pacific.

Now, some mitigating factors …

• Before the recent 30% tumble, the Chinese market has went up 150%. Even after this massive tumble, it’s still up about 70% from a year ago. So maybe not all investors lost money.
• The Chinese stock market, like its internet, is walled in. Foreign investors can only invest in Chinese shares in the Hong Kong market, which is much more mature and stable. This has the effect of containing the economic disaster within China.
• As my client, your exposure to China is about 2%, nearly all of that through the Hong Kong market.

In summary, the situation in China bears close watching. The economic impact on us is limited, but fear can not be walled in, fear could spread to other Asian markets and even to our shores. Should that happen, remember what FDR said: “The only thing to fear is fear itself.”

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