Must-read: Olivier Blanchard: “The Price of Oil, China, and Stock Market Herding”

Must-Read: Olivier Blanchard: The Price of Oil, China, and Stock Market Herding: “The main effect of a slowdown in China would be, through lower commodity prices…

…help rather than hurt the United States…. The oil price explanation… is even more puzzling…. It was taken for granted that a decrease in the price of oil was good news for oil-importing countries…. We learned in the last year that, in the short run, the adverse effect on investment on energy producing firms could come quickly and temporarily slow down the effect, but this surely does not undo the general conclusion. Yet the headlines are now about low oil prices leading to low stock prices…. [Not] convincing… [is] that very low prices lead to such serious problems for oil producers that this will end up… dominating the scene… [or] that the low prices reflect a yet unmeasured decrease in world growth…. Maybe we should not believe the market commentaries. Maybe it was neither oil nor China….

I believe that to a large extent, herding is at play. If other investors sell, it must be because they know something you do not know. Thus, you should sell…. So how much should we worry? This is where economics… gives the dreaded two-handed answer. If it becomes clear… that fundamentals are in fact not so bad, stock prices will recover…. [But] the stock market slump… can become self-fulfilling…. Hope for the first… worry about the second.