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Similarities Between China's Stock Market Crash And 1929 Are Eerie
Submitted by Money Morning's David Zeiler via Contra Corner blog,
For students of history, the China stock market crash looks eerily familiar.
It’s playing out much like the Wall Street stock market crash of 1929.
In case you’ve been distracted by such things as the Greek debt crisis and a bizarre glitch that shut down the New York Stock Exchange for more than three hours Wednesday, the Chinese stock market has been in a free fall lately.
Although it rebounded late last week thanks to more government intervention, the Shanghai Composite Index has shed 29% over the past month.
An equivalent loss for theDow Jones Industrial Average would be a drop of more than 5,100. Paper losses already exceed $3.25 trillion.
This follows a dramatic run-up of 150% in the 12 months leading up to mid-June.
That’s disturbing enough, given how interdependent the global economy is today. But the similarities of the China stock market crash to the Crash of 1929 make it particularly troubling.
Both have prominently featured failed interventions.
Back in 1929, it was the big bankers of Wall Street that tried to stop the bleeding. The top names of the day – Morgan Bank, Chase National Bank, and National City Bank – pooled their resources and tried to prop up the market by buying shares of blue-chip stocks such as United States Steel Corp. (NYSE: X).
But the strategy could not overcome the wave of selling, which eventually dropped the DJIA 89% from its peak.
In China, the government has done just about everything it can think of to halt the Chinese stock market crash. The government has:
- Loaned $42 billion to 21 brokerage firms to buy stock
- Announced a $40 billion economic stimulus plan
- Allowed half the listed companies to stop trading of their shares
- Prohibited controlling shareholders and company board members from selling any shares for six months
- Put all IPOs on ice for now
- Instructed the People’s Bank of China to cut interest rates by 0.25%
- Announced a crackdown on short selling
These drastic measures have succeeded in only briefly reversing the China stock market crash.
And the reason why echoes yet another parallel with the 1929 crash…
The Real Cause of the China Stock Market Crash
One of the factors fueling the soaring stock market of the 1920s was an influx of new, financially unsophisticated investors who saw the rising numbers and saw an opportunity for quick and easy profits.
And that’s exactly what’s happened in China over the past year or so. Making matters worse is that these inexperienced Chinese investors tend to follow a herd mentality.
“Chinese individual investors are not primarily ‘value’ investors. Sky-high valuations don’t seem to faze them. They are primarily momentum investors who buy whatever is moving and sell whatever is falling,” financial expert John Mauldin wrote in his “Thoughts from the Frontline” e-letter last week.
And many of these investors were willing to borrow money – trade on margin — to enhance those profits.
“Almost every account that’s been opened in China comes with a margin agreement and access to margin. Margin lending is big business in China, as it is here in the U.S.,” saidMoney Morning Capital Wave Strategist Shah Gilani.
Margin trading was a big reason the 1929 crash was so severe. In margin trading, an investor borrows part of the money – in the late 1920s as much as 90% — to buy more stock.
That’s great when the stock rises, but becomes a major problem when it falls.
The Dangers of Margin Trading on the Stock Market
That’s because the lower stock price reduces the equity the investor has while the amount owed remains the same. Once a stock falls to a certain point, it triggers a “margin call.” The broker holding the loan asks for more cash to get the ratio back to where it’s supposed to be.
For many small investors, the only way to get that cash is to sell some of their shares. Of course, a lot of margin calls causes a lot of selling – and forces prices down even more. And that triggers still more selling.
That’s what happened in 1929, and that’s what’s happening now in the Chinese stock market. While government intervention can slow this kind of decline temporarily, it can’t stop it.
And in China we still have a long way to go.
“Until the margin buyers are gone, we don’t expect a stabilization or possibility for the market to start heading higher again,” Sean Yokota, head of Asia strategy for SEB Bank, told MarketWatch. “We are only one-third of the way through [deleveraging].”
The 1929 crash is remembered for a few hectic days in October of that year, but the market didn’t bottom out until July 8, 1932. The Dow Jones did not return to its 1929 high until Nov. 23, 1954.
That’s not to say China will suffer just as severe a collapse. But the Chinese stock market is on shaky ground right now.
Gilani believes U.S. investors need to keep a close watch on the situation in China. He’s against advising panic selling, but recommends investors have stop-loss orders in place in the event the China stock market crash inflicts collateral damage on the global markets.
“In spite of everything Chinese authorities and regulators are doing to shore up the stock market, there’s a better than 50% chance their efforts will fail and that a devastating crash could send global markets back into a 2008-era financial crisis,” Gilani warned.
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Long-term thinkers. 5000 years of history. They play chess while we play checkers. The chinese government can wave a hand and get rid of all debts.
And yet here we are.
No, you cannot wave a hand and get rid of debts. You can wave a hand and make defaults legal and universal, as the government. No one else can do that.
You also cannot wave your hand and make everyone wealthy, the flip side of defaults.
All debt, prosperity and economic interactions are based on a system of trading real goods and services. It is why you cannot print enough money to have everyone stop working. It can never happen.
When you default, someone loses real money, real work they did and real value somewhere in the system. If Greece defaults, retirement acounts, investment accounts, taxpayers, all lose stuff they earned and lent to Greece. Favoring default simply favors one side of an economic trade.
Many believe that China's success is the result of superior long term planning by their government. When the truth is, China's success is simply the result of a shift from communism, which simply doesn't work, to fascism which incorporates just enough capitalism to be successful. Sure once in a while they do things that appear to be a good idea, but so too did the soviets.
"Investors need to take steps to protect themselves in case the China stock market crash starts to drag down U.S. stocks."
LOL! No gonna happen.
Depends, a lot of American corporations are heavily invested in China with no way to get out and it'll be hard to write it down.....
Well said, Captain. Fascism, economically is just Communism with some market forces. The state is still supreme, one party power, autocracy but it, fascism allows some trading. However, over time I do not think autocrats can resist intervening and wrecking things.
Fortunately, here in the "free" West we do not do these sort of interventions and controls. Well, maybe some...okay, quite a few...hell, I suppose we will get the same results if we do the same things.
There are no free markets anywhere.
I'm sure Dindu didn't mean 'wave a hand." What he prolly meant was 'wave a junta."
Which is what the neocons are going to do here when the US debt hits $20 trillion.
difference being, in china they will stop you from selling :D
The Banks SAID they were buying in 1929.
That doesn't mean they actually bought however because "there was no default to gold" by then.
So instead INVESTORS took it on the chin...and that wound up including the entire US economy. Not even the Federal Government which became massive from it was able to bail out USA Inc from that one.
DJIA wouldn't hit the 1929 high again until the 1960's....and by then money had no meaning so "hard to call that a new high."
In "1929 dollars" the DJIA probably didn't hit another record high until 1986 actually.
Been "off to the races" ever since though.
So much of the "debt work off" from 2008 has been Yuan/Dollar...awful lot that can go wrong here.
Some of those LTCM trades were levered over a thousand to one back in the 90's.
Vet, there is an interesting concept I would like to research, actually two. The first is 100% reserve banking and the second is whether you actually need banks as we now have. I am wondering if the internet will render banks obsolete or a second class player.
Good history, BTW. Here is the first idea. You are actually able to take your money in cash and simply save it. You can put it under a mattress, in a home safe or go to a bank and put into... not in an account, but in a safe deposit box. You will never ever run out of cash and everyone can survive a run on the banks...because there will be no levered accounts. If you use a safe deposit box you will pay a fee to the bank.
Secondly, you could take your cash and buy "credits" at a service like PayPal. You use that account to pay your bills and what-nots. They do not act as a bank loaning out your money. There is no run on the Paypal accounts like you see in Greece.
I am not sure what the future holds but realize that all these crashes are problems that government creates for you and me by wandering into markets, private markets and mandating how we trade. The Fed purposly fixes fake interest rates at zero ot push you, grandma and Fidelity into equities far past their actual value. Things like margin accounts should be a private market rule and risk. You can do or not do them. Because government links so many things together we all get to participate in every bubble, every crash and every risky trade. This is the origin of the evil crony-statist problem.
Joe citizen Ho Lee Fuk and Mi Ping Sum Di Wong thinks they're fucked and that something is very wrong.
Love these guys who super impose period charts over each other. 84 years ago, no less. Who knew it was so easy? I think they call it cognitive bias ...
There are other similarities, such as an explosive decade of growth, misallocation of resources, wild RE speculation, stock margin debt, moving from an agrarian to industrial economy etc
more important than 'stock margin debt' was the ability to buy stock on 10% margin.
I bet ALL market crashes look similar ---- an up trendline, followed by a steeper crash, with a period of side-way in between....
All market bubbles and popping look similar, but don't confuse bubbles with crashes. Dow Jones 1929 was a bubble bursting, but it did not bring about the Great Depression nor cause a market crash. The Chinese market now is a bubble being popped, just like the 2000 NASDAQ.
The Dow charts from the 1930s show the crashes. For more recent crashes look at the 1987 and 2008 charts of the US equity indices. Crashes start with a steady decline, then a sharper decline which then turns into a collapse.
blah blah, hang the evil short sellers, send them to the gulag, except in the case of herbalife which is a complete scam
If an exchange is private they can set their own trading rules. We as private citizens can choose or not choose to participate. They can make their own rules on margins, naked shorts and the likes.
The problem is government getting in.
you sir, Mr. Robert Merry, are a reality-detached dweeb living in the confines of corrupt DC for decades of numbness, unable to tap into, or even guess at, the temperament of the American people. does somebody really pay you for shit like this?
Mainstream thinking in finance believes in the "efficient market hypothesis" and that stock markets move in a "random walk".
I've had problems with those ideas. After all, my internet name here is Heterodox economics. :) It seems that there are rare occasions when the market goes to extremes, and that such extremes, whether severe overbought or severe oversold, can be identified.
That the Chinese stock market was in a bubble was identified months ago by various people, including Zero Hedge.
Here's one way to identify a stock market bubble: if a stock market increases by more than 75 percent in two years or less, you have a bubble. According to EconStats, the DJIA went up 28.753% in 1927 and 48.221% in 1928. We all know what happened after that.
http://www.econstats.com/eqty/eqea_na_4.htm
Looks like China man investor will need to sell his gold to cover the margin requirements...I guess the gold price is going down again..too many sellers.... Yikes...I got into the wrong market again...