As the media become more sensationalist about stock market falls, the world economy grows ever more immune to their effects, writes Marc Coleman, Economics Editor

To read some commentators, you would almost think they were disappointed that falls on world stock market have not caused panic about the global economy.

The trauma of Black Monday - the crash that occurred on October 24th, 1929 - still lingers in the minds of some economists. The Dow Jones lost 20 per cent of its value that day and share prices stayed on the floor, plunging the world economies into recession and leading, ultimately, to the second World War.

When share prices fell by 22.6 per cent on October 19th 1987, the world closed its eyes only to open them again and discover that, no, the sky had not fallen on our heads; that stock markets were on course for an orderly correction, and that the world economy was not heading for recession.

Last Tuesday, the Dow Jones fell by 3.3 per cent and other leading international markets suffered falls close to this magnitude, following falls in the Shanghai composite index of around 9 per cent.

Yesterday saw some minor aftershocks.

On the one hand, further substantial falls cannot be ruled out: in the 1929 crash, share values took around a week to reach their bottom level. Two further falls of around 11 per cent occurred in the week after the original fall and this is what put the nail in the coffin of market sentiment. But the fact that no significant falls have occurred since Tuesday's drop is very reassuring.

So are the origins of that first fall: Chinese stock markets have not yet caught up with with the discipline and quality of governance that characterise those of the US, Japan and western Europe, though they are doing so. The practice of carelessly borrowing money from banks to invest in shares has been growing in a worrying way.

Rumours circulating last Monday to the effect that the Chinese government would crack down on this behaviour caused panic selling.

Far from being something to worry about, what happened was healthy. Mildly over-inflated by speculative investment, a small bubble was burst before it grew too large.

The international impact - some jitters on the Dow Jones, FTSE and other key markets - was temporary and short-lived.

International markets appear to recognise this for what it was: a localised affair blown out of proportion by investors.

So what's the problem? The first problem is that the media has become more sensationalist about financial market developments than before.

On October 25th, 1929, the Wall Street Journal had this to say about the events of the day before: "Considerable profit-taking came into the stock market at times yesterday after the triple holiday, but in most instances this supply was absorbed easily. New leaders were brought forward and attracted heavy buying. . .". Boring and understated in the extreme, the report failed to communicate the genuine threat that a 20 per cent single-day fall in any stock market poses.

Now consider the headline of one leading international newspaper last Wednesday in response to a fall of 3.3 per cent in the Dow: "Shares tumble around the world".

Ironically, as the media become more sensationalist about stock market falls, the world economy is becoming ever more immune to their effects.

The world of 1929 was very different to that of today. For a start, markets were less global. If US investors turned away from US shares, there were fewer others willing to take a bet on them recovering. The strength of last Tuesday's market falls on the Shanghai market reflects a market that is more inward and less diversified in terms of the investors that buy and sell shares there.

By contrast, the Dow Jones and FTSE are two of the world's most accessible markets. For every investor betting on a doomsday scenario, there are relatively more investors likely to take a calmer, longer-term view and stay in the market. The result is less volatility in prices.

And even if more developed markets did experience 1929-sized falls, global policy co-ordination has become far more developed since then.

Following 9/11, sharp falls in world markets were quickly contained by rapid co-ordination between the US Federal Reserve and the European Central Bank, both of which implemented emergency cuts in interest rates.

Cuts in interest rates usually boost share prices because they act to reduce the amount by which future cash flows must be discounted. (Shares in a company are valued by discounting the expected cash flows arising from the company's future activities.)

The rapid response of 2001 reflects a far greater degree of contact and mutual understanding between the world's central banks and its financial regulators.

Freer trading and better management of global exchange rates are other factors that contain the impact of share price falls: the falls of 1929 were followed by protectionist policy responses.

Declining share prices cut into wealth and consumption levels and this tended to reduce world trade. In response, the world's leading economies devalued their exchange rates to keep domestic exporters competitive.

The approach - known as "beggar thy neighbour" - ended up beggaring everyone as a downward spiral of devaluation ensued, bringing world trade down the plughole with it, a development worsened by the erection of trade barriers.

While increased trade liberalisation is becoming increasing difficult in a post-Doha world, the chances of going back the bad old days of increasing protection is unlikely.

For all of these reasons, any significant share price falls are likely to be localised affairs whose impact on world markets is muted and whose economic effects are marginal.

Does this mean there is no threat to the world economy? Not at all.

It simply means that stock markets - well diversified in terms of the products traded and the types of investors who trade there - are not where such a threat is coming from.

As was pointed out this week by Friends First economist Jim Power, there is one market that stands out as a threat to the world economy. In terms of the diversity of the product and investors that define it - not to mention the degree of indebtedness that sustains it - the US housing market is the market to watch in coming years.

If Ireland's Iseq index has fallen in recent days, it is more likely to have to do with our own housing market than any concerns about China, even though those concerns prompted the week's events.