Tuesday, January 11, 2011

Bangladesh Stock Market Crash: Evidence of Inflation Driven Markets

Here is more proof that stock markets around the world have been mainly propped up by inflation (bank credit expansion)

If you recall, we earlier noted that the stock market of Bangladesh (Dhaka Index) posted as the second best performer in the world in 2010 gaining nearly 83%.


Chart from Bloomberg

Yesterday fortunes seem to have reversed, as the Dhaka index suffered a record crash. This provoked street riots and prompted for the forced closure of the exchange.

image Picture from Marketwatch.com

According to Sify News

Stock exchanges in Bangladesh were forced to close down for the day Monday after share prices registered their biggest fall ever and investors took to the streets.

Angry investors vandalised some vehicles and set fire to tyres as they demonstrated in Motijheel area in the heart of the national capital.

People have been lured by easy money where “over three million people - many of them small-scale individual investors” had been affected by the crash, according to a BBC report. A crash reportedly brought upon by a “series of measures” implemented by authorities to restrain “overvaluation”.

Here is a short BBC report…

The series of measures involved the raising of the cash reserve requirements for banks…

From AFP

On December 15, the Bangladesh Bank had raised the cash reserve requirement (CRR) by 50 basis points, tightening money supply in a bid to rein in soaring inflation.

Analysts, protesters and the SEC say this is what triggered the collapse as some banks, which had invested heavily in the market, tried to offload their shares quickly in an attempt to meet the new requirements.

and the curtailment of industrial loans that was being diverted into the stock market.

From Sify news

The limit for giving loans by the banks to their subsidiary companies was set at 15 percent of their total capital, but many banks invested more than the threshold only to increase their stakes in the capital market. BB had earlier directed the banks that invested more than the ceiling to adjust the excess amount by December 31.

Also, the central bank set January 15 as the deadline for the banks to recover loans taken by borrowers as industrial credit but were diverted into the share market.

And as Austrian economist Fritz Machlup correctly postulated

``If it were not for the elasticity of bank credit, which has often been regarded as such a good thing, a boom in security values could not last for any length of time. In the absence of inflationary credit the funds available for lending to the public for security purchases would soon be exhausted, since even a large supply is ultimately limited. The supply of funds derived solely from current new savings and current amortization allowances is fairly inelastic, and optimism about the development of security prices would promptly lead to a "tightening" on the credit market, and the cessation of speculation "for the rise." There would thus be no chains of speculative transactions and the limited amount of credit available would pass into production without delay.”

Bank credit expansion plus retail investor euphoria seem as prima facie evidence of the Boom Bust cycles brought about by easy money policies.

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