Viewing the referenceless global financial markets, one can rightfully wonder whether Einstein received his Nobel Prize for physics or for economics. True, that most (including the writer here) of us don’t understand his famous Theory of Relativity in the context of Physical Universe, however there is no need to look further from our own financial markets now and mentally travel billions of light years away to make sense of that theory.

 

A plain simple look at what’s happening in global economy and in our 24X7 financial markets would help us make better sense of the Theory of Relativity. And once the clarity is established, one can legitimately state the genius in Einstein legitimately deserved another Nobel Prize for economics, probably even more than for physics.

 

Sad that the judges for economics didn’t understand its importance as the theory was much ahead of its time, more so in the period when Bretton Woods system tried to maintain a reference system that badly failed in 1971.

 

The basic premise of the Theory of Relativity is what we observe around us, in time and space, is not absolute and varies from our own reference system and its inherent bias. Now ask any man on the street whether Dollar is overvalued, and the question comes ‘against what reference system’– you can have a basket of forex measures (as in Dollar Index), you can have non-currency based measure like crude, gold, real estate. So unless you define your reference system, it’s all relative, floating in the air in the referenceless monetary world where one often gets confused on what’s the measure and what’s being measured.

 

Answers to all the billion-dollar questions that hound us – be it is China witnessing a bubble in its stock market, is Chinese economy heating up, is the U.S. likely to face a recession within this year as stated by legendary Greenspan, has the real estate bubble been busted adequately in the U.S. or more to come, are the high asset prices in emerging nations likely to have a correction – you name it, and one can be reasonably sure that none of these are better answered by any economic theory other than an extension of Einstein’s Theory of Relativity in its pure economic sense.  And that simple answer is same for all the questions, answers of which even elude present fed-chief Bernanke ‘It depends on your reference system’. And that reference system happens to be a dynamic one.

 

Or why go that far? Just asking simple questions to ourselves whether we are rich or poor gets a similar response. Majority of us are filthy poor when compared to the filthy few rich billionaires, however changing the reference system again; we can feel happy that we are filthy rich compared to the large majority of filthy poor people we have in this very world.

 

In physics, in-spite of accepting the Theory of Relativity like the words of the Bible, scientists still believe that everything isn’t indeed relative, there exists few absolute things as well. There exist few constants like the speed of light in the space, and many more. In our number driven global economics and financial world, there exists no constant and no concept of something absolute. It’s all relative. Economies of nation-states are compared without any absolute measure, stock-prices are compared with peers without any absolute reference system, true – there exists historical trend lines; however history proves that we never learn enough from past history (mistakes) and it also states that history gets created all the time.

 

And only this week, there’s been one more casualty to this Theory of Relativity. Majority of us grew up with sort-of universal economic statements like ‘when the US sneezes, rest of the world catches cold’. The volatility, started from Shanghai markets on 27th of February when its index dropped by closed to 9%, ensured that the rest of the world also sneezed, if not caught cold. Markets in the U.S. dropped by more than 3%, and that reference system triggered a tsunami wave all over, from Japan to India to the European markets.

 

Chinese markets account for a bare 2% of global market capitalization, the U.S. accounts for nearly 40%. So a drop of 9% over 2% was a meager 0.18% drop, in value terms it was little more than $100 billions, whereas the drop of the U.S. markets wiped off, well albeit for a day, closed to $700 billion of investors’ wealth.

 

Newton, the other known physicists stated in his famous laws that every action has an equal and opposite reaction. However an action of the value of $100 billion should not necessarily evoke response of trillions of dollars from the rest of the world, unless there is leverage that provides the delicate balance within our global financial imbalances.

 

China, with its nominal GDP and market-cap may still be the 4th largest GDP accounting for 5-6% of global GDP; and in market-cap, may even rank lower. However when one visualizes a global economic picture like Atlas bearing the world with hundred pillars instead of his two powerful hands, each pillar on book supporting 1% of the earth’s weight; China merely accounts for 5-6 of those pillars in economic sense and measures. However try removing even one of those pillars that China provides, and we see an earthquake in global financial world. And if one mischievously removes 3-4 from that of Japan, the U.S. or the European Union; one barely notices that until the number grows reasonably large.

 

That’s the Theory of Relativity of the China impact. In a world of full of relative measures, starting from the GDP to the value of currency by which everything gets measured; the old adage, taken to be absolute  for a while that when the U.S. sneezes, rest of the world catches cold is also undergoing a change. True, it may be that China caught cold for a day and rest of the world sneezed (in % terms), and China recovered fast the next day (and falls again today, 1st March as of now) whereas the rest of the world didn’t have it easy as of now. The sneezes from China, triggered by the comments of Greenspan or by wishful thinking of the Chinese Government who (insensibly) wanted the markets to be sensible, forced the U.S. Government and Bernanke to comment on status of U.S. economy to comfort their own market.

 

Lately people talked about China for its impact in commodity markets – whenever commodity Chine sneezed, global commodity markets caught cold. The incidents of present week make its mark in global financial world as it threatens that status that the U.S. economy enjoyed in global economy since World War II.

 

Is it a new beginning? Only last week, the U.S. vice-president Cheney showed his concerns over rise of China’s military power in the Asia-Pacific region, still incomparable compared to the strength of the U.S. military. Market forces are strong, and getting stronger by the day; at the same time markets can be exuberant and be unreasonable. One thing the policy-makers in the U.S. won’t be comfortable about is this response of the market. It would take them some time to accept that sooner or later, whenever China would sneeze; rest of the world would literally catch cold.

 

Well, they may at most hope that with this change of reference system; the U.S. too gets a promotion and that be ‘whenever the U.S. sneezes, rest of the world would catch influenza’.

 

Following the Theory of Relativity, we can only explain that better when our reference system takes us there.  Only wish we would like to have is it should not be a chain reaction – China sneezes, rest of the world, including the U.S. catches cold, and that in turn causes global economy to have recessionary influenza.

 

One can be reasonably certain that the Theory of Relativity would hold true for that hypothetical nightmarish scenario as well.

 

 

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