China’s Stock Market Crisis: Parallels with Wall Street 1929 and Japan’s 1989 Crashes

The Quartz draws parallelism of the current stock market crisis in China to Wall Street’s 1929 and Japan’s 1989 episodes.

The similarities with 1929 by stage (according to Quartz): Booming GDP, Boundless optimism, Property boom-and-bust, easy credit, Epic stock market surge, Margin trading rampage, Investment trusts abound and finally Rescue efforts

The Quartz on the 1929 rescue efforts and China's current response: "Even though the stock market officially crashed in October 1929, it suffered an alarming minor collapse in March of that year too. In both instances, corporate barons stepped in to stabilize the market and prevent margin calls from compounding the selloff. The first instance—when Charles E. Mitchell, head of National City Bank, announced that the bank would loan up to $25 million to the call market—halted the March slide. However, an October effort by a coalition of bankers to prevent a collapse by buying up shares of big companies failed. Both approaches are similar to what the Chinese government has undertaken to stop the mid-June crash from triggering margin calls."

What’s even more interesting has been the likeness of Japan’s 1989 stock market crash. The resemblance seems deeper considering these factors: investment-led growth model, state dominance, the perils of the “land standard” and Crumbling corporate profits 

In short, China’s current model signifies a marriage of two worst worlds which led to an economic crisis where a stock market crash served as a trigger.

But what stirred my interest is how the article differentiated Japan 1989 version with the US 1929 counterpart

Again from Quartz: (bold mine)

Japan made a different mistake

Japan avoided a depression after its stock crash—and the property market collapse that followed—by furiously expanding money supply and by ramping up government stimulus to replace vanished demand. So why is it still struggling to escape from its “Lost Decades”?

Bureaucrats and bankers believed that with enough time and loose money, they could grow out from under the debt burden.

(Hoshi and Kashyap.)

But Japan had too much debt for that approach to work. Loose money only went to keep broke companies alive—a phenomenon called “zombies”—instead of funding productive investment that might spur the economy. The chart below shows the percentage of bank customers whose loans were being rolled over. By the late 1990s, around 30% were being kept alive by this subsidized credit:

 

("Zombie Lending and Depressed Restructuring in Japan," Caballero et al.)

On top of that, by investing so heavily in industry, Japan built itself the capacity to churn out far more goods than anyone actually wanted to buy. The trouble isn’t just that money could have been spent better building the means to make things people truly wanted. It takes a long time for a factory to need replacing. With enough industrial capacity to last it for many years—even decades—Japan had few other options in which to profitably invest. Fiscal stimulus couldn’t make Japanese industry more productive, therefore. So as Japan waited a decade for growth to kick in once again, its debt pile mushroomed even more.

The lesson Japan failed to master is that too much debt makes it near-impossible to grow—and that the only way to get rid of that burden is therefore to recognize losses.

Whereas in the Great Depression, lots of companies and banks went bust, in 1990s Japan, hardly any did. America’s bankruptcy epidemic destroyed huge sums of wealth and, as a result, damaged the economy. But it also cleared away debt problems, preparing the country to borrow, invest, and grow again. While the Great Depression lasted just shy of a decade, Japan’s debt woes haunt it to this day, more than 25 years after its stock crash. Much of it’s simply shifted onto the Japanese government’s balance sheet. The threat of deflation still looms.

I have written about this here and here. All those bailouts and market interventions to prevent market clearing have only spurred two lost decades and today’s desperation through Abenomics

Lessons from the above

-governments’ response has always focused on the short term popular fixes. Yet short term actions lead to unforeseen long term consequences

-no crisis is similar. While the root will always be DEBT, the manifestations will be different. That’s because of the distinct character of the political, economic and financial structures. In China’s case, current episode merges the worst traits of both Wall Street’s 1929 and Japan 1989 crisis.

While China may not be in a full crisis mode yet, all these bailouts including the $483 billion stock market subsidies are signs that the crisis is just around the corner.

-finally the Chinese government seems to have hardly learned from history.

This validates German philosopher’s Georg Wilhelm Friedrich Hegel prescient observation: What experience and history teach is this — that nations and governments have never learned anything from history, or acted upon any lessons they might have drawn from it. Lectures on the Philosophy of History Vol 1 of 3 (1832)