What lead to Chinese Stock Market slide

The teleprompter readers were gleeful on Tuesday as the market came to life for the first time in almost a year. The Dow Jones dropped 416 points, losing 3.3%. The selloff was sharp. The US equity market lost 300 points in the space of a few minutes.

Many people were searching for explanations. Former US Federal Reserve head Alan Greenspan's comments, US Vice President Dick Cheney's visit to Asia, the escalating tension between the United States and Iran and the deterioration of sub-prime mortgage providers were offered as plausible explanatory causes.

However, all the telltale signs pointed to the 9% selloff of the Shanghai Composite Index. The major media services were struggling to understand how a correction in an emerging-market country such as China could possibly have an effect on the US. Yet Tuesday's events confirmed the new reality. Not only do events in China matter, the Middle Kingdom is now one of the main drivers of global economic activity and one of the main barometers of global risk conditions - and this is very good news for all commodity producers.

The so-called "meltdown" occurred in slow motion. The indices gained momentum as the day wore on, accelerating prior to the close. Most of the activity was concentrated in the equity markets. This was not too surprising, given that the equity markets posted the largest gains over the course of the past two years.

The Bovespa (Sao Paulo) lost 6.6%, the Bolsa (Mexico) dropped 5.8% and the Merval (Argentina) surrendered 7.5%. The effect on the fixed-income market was muted, with the exception of some of the recent corporate bond issues. The GDP (gross domestic product) warrants also suffered - losing more than 5%. The GDP warrants, of course, are high-Beta assets and very vulnerable to changes in market sentiment. Investors looked for safety, moving into Treasuries, gold and short-term assets. Investors are definitely moving into more defensive positions, but they should not get overwrought with fear.

The correction in the Chinese market was not associated with any fundamental problems. China's level of economic activity is sound. Exports are strong. International reserves are high. The banking system is improving. Inflation is under control, and the political environment is stable. So what's the problem?

The problem is that, after lying dormant for more than five years, the Chinese equity market went into a tear last year - rising more than 170% in the space of 14 months. Changes in regulation, a slew of initial public offerings and greater wealth accumulation by Chinese retail investors led to a surge in the Shanghai equity market - fueling worries among policymakers about the creation of a speculative bubble.

The Chinese economic authorities (prudently) issued warnings at the start of the year that the speculative frenzy in the equity market was reaching problematic proportions. Finally, the monetary authorities threatened that they would employ drastic measures if equity investors did not calm down. Tuesday's selloff was the market's reaction to that threat. However, the selloff did not reflect concerns about the health of the Chinese economy.

The over-arching impact of the Chinese selloff was a clear indication of China's importance. The rising wealth of China, and that of its enormous population, brought new life to commodity producers.

The impact of the Chinese correction on Latin America was significant, but muted. Latin America is no longer a speculative play that depends on global risk appetites. The region is an exporting powerhouse, dominating strategic natural resources, generating enormous levels of international reserves and developing an immunity system that will reduce its dependency on global liquidity conditions.

The BRICs (Brazil, Russia, India and China) may be falling, but more like a ton of bricks clattering on the announcement of the new global economic order.