JUST over three weeks ago as last year was drawing to a close, stock markets across the globe were partying like it was 1999 all over again.

And why not? They had good cause to be celebrating a seemingly miraculous recovery from a near-death experience just months earlier.

As a new year and a new decade kicked off, hope abounded that the rally would roll on. Some initial uncertainty in Asian markets was soon swept aside by exuberance on Wall Street, fired by optimism that the United States economy was finally well on the road to recovery.  

But how things can change rapidly. In the past week, measures unveiled by China to curb lending as well as pre-emptive strikes made by the Obama administration against proprietary trading by US lenders have started to give investors cold feet about the new year.

The moves by the two economic giants led to a rout among major stock markets - a grim reminder of how the fates of smaller bourses such as Singapore's are now inextricably linked with the heavy hitters like Wall Street and Shanghai.

Still, while markets were unnerved by these measures, they may actually be good for investors in the long run, if they help to prevent asset bubbles from building up in the financial markets.

First, consider the nervousness sparked off by China's announcement.

It is no secret that the flood of cheap credit unleashed by mainland lenders has led to soaring asset prices, particularly in the property market.

Fears abound that this might generate a bubble so huge that when it finally bursts, it will derail China's economy - now the world's biggest growth engine.

Certainly, the data reflects a level of buoyancy akin to the wild exuberance experienced in 2007 before the party was cut short by the sub-prime crisis in the US, which erupted to become a full-blown global financial crisis.

In the first two weeks of this month alone, mainland banks extended as much as 1.1 trillion yuan (S$225 billion) in new loans. This is on top of the 9.6 trillion yuan they lent out last year.

Throw in another four trillion yuan of spending by Beijing to stimulate the economy in the past year, and the huge amount of cash sloshing around in China's economy is a scary spectre.

All that money has to go somewhere. Certainly, some has been put to productive use such as building roads, improving sorely needed amenities like hospitals and cleaning up the environment.

But huge sums have been siphoned off into speculative investments in the real estate and stock markets. It explains the outperformance of the Shanghai bourse, which jumped 80 per cent last year, and that of nearby Hong Kong, which was up 52 per cent.

Another reading of all this, however, is that the regular boom-and-bust cycles in China over the past decade represent the birth pangs of an emerging economic superpower. For some historical perspective, just take a look at the US in the 19th century. The then emerging world power suffered a similarly violent series of booms and busts, as it grew rapidly to become the world's pre-eminent economy.

Certainly, the recent data coming out of China reinforces this perspective.

Last year, it overtook Germany to become the world's largest exporter.

It is also the world's No.1 market for motor vehicles, after 13.6 million cars were sold there last year. Only 10.6 million were sold in the recession-hit US.

The Shanghai stock market is also now the most active in Asia, with US$5 trillion (S$7 trillion) worth of shares changing hands last year.

All this means that far from being jumpy, investors should be thankful that recent actions by China's central bank to cool the over-heated loans market may help engineer a badly needed soft-landing for the red-hot property and stock markets on the mainland.

Now then, if China is not in fact a bogeyman to cause well-founded jitters in the stock market, how about the US?

Last week's proposal by President Barack Obama to reform the US financial sector by slicing the banking business away from proprietary stock trading, hedge funds and private equity took Wall Street by surprise. Billed the 'Volcker rule' after its architect, former US Federal Reserve chairman Paul Volcker, it is set to unleash the most far-reaching changes in the US banking sector since the Glass-Steagall Act which separated commercial banking from investment banking more than 60 years ago.

The philosophy behind the proposed change: Banks should no longer be able to act like giant casinos, placing big bets on financial markets. They should stick to good old-fashioned banking.

No doubt, Wall Street took fright at the proposed reforms and the Dow Jones Industrial Average fell 4.1 per cent over Thursday and Friday.

But consider the alternative. Since the Glass-Steagall Act was repealed in 1998, the US has been through the bust-up of two horrible asset bubbles which dragged the rest of the world down with it.

The first, just after the dawn of the new millennium, killed off a dot.com frenzy and left stock markets in a bear grip for three years. The second, the bursting of the sub-prime bubble in the US mortgage market, was more dramatic - even killing off huge financial institutions such as Bear Stearns and Lehman Brothers.

The beauty of Glass-Steagall was that for decades it had worked, delivering stability to US financial markets and reasonably stable equity market growth.

Proposing a ban on proprietary trading by US lenders may be the nearest modern equivalent of Glass-Steagall.

Current jitters suggest that investors are unhappy with a move that would force US lenders to rely on their traditional low-margin loans business for their bread and butter once more.

In the longer term, such a reform may well enable the financial markets to shake off the wild booms and busts that come from allowing banks to trade in all kinds of assets on their own accounts.

For traders, it certainly spells a more volatile market ahead. Besides having to worry about China's volatile real estate market and the risk of default by sick economies like Greece, they will also have to contend with every twist and turn of the 'Volcker rule' as it makes its way through US Congress - where President Obama has just lost his 'super majority'.

Interesting times indeed - and a chance for long-term investors who believe that something positive will pan out from all these developments.

Source - http://www.straitstimes.com/Money/Story/STIStory_481622.html