TheStar
In this article, we do a case study on the Great Depression of 1929
There are a few similarities between the current economic state in China compared with the US economy in 1929. While China currently dominates the world’s products, industrial goods from the US dominated in 1929.
Lately, as a result of economic overheating, the Chinese government was forced to increase interest rates to curb inflationary pressure and excessive stock market speculation. This scenario is quite similar to the situation in 1929, when the US Federal Reserve increased its discount rate from 3.5% in February 1928 to 6% in August 1929.
The Great Depression in 1929
It all started after World War I. While the British and German economies were much weaker after the war, the US economy was relatively stronger. As a result of less damage caused by the war and rapid technological progress in its industrial production, American industrial goods dominated the world market during the 1920s.
Before the crash in 1929, US gross national product grew at an annual rate of 4.7% and unemployment was at an average of 3.7% from 1922 to 1929.
The fundamental reasons for the rise in stock prices were the increase in productivity and good corporate earnings. Besides, the expansion of loans to brokers was also a crucial feature of the 1920s bull market. This expansion resulted in the creation of an economic bubble.
In addition, the growth in consumer credit accelerated the expansion. As stocks could be bought with just a 10% margin, the easily available credit led to the speculative mania back then.
According to John Kenneth Galbraith in his 1954 classic “The Great Crash in 1929”, the ability to purchase stocks on margin was the biggest culprit in causing excessive speculation. A buyer needed only to provide 10% capital and borrow the rest, while enjoying the full capital gain less the interest on the borrowed funds.
For retailers who lacked sufficient capital to purchase stocks, the massive growth of investment trusts eliminated this obstacle. The investment trust, which served the same function as mutual funds do today, grew from about 40 in 1921 to over 750 in 1929.
The Fed’s tight monetary policy before the crash in 1929 was a consequence of its fears over excessive credit for speculation. This scenario is quite similar to what the China central bank is worrying about now. During 1929, the average price-earnings ratio and price-to-book ratio were 30 times and 4.25 times respectively.
As a result of tightening interest rates, some businesses were in trouble long before the crash. Automobile production tumbled from a peak of 622,000 in March to only 416,000 in September. In July 1929, despite the strong stock market momentum, the effect of interest rate hike on the US economy started to threaten corporate earnings growth and undermine the fundamental value of stocks.
From the low of 63.9 on Aug 24, 1921, the Dow Jones Industrial Average (DJIA) surged almost 500% to 381.2 on Sept 3, 1929. However, it tumbled nearly 90% before bottoming out at 41.22 on July 8, 1932.
There were credit squeezes and liquidity panics during the market crash in September 1929.
The withdrawal of foreign funds and US banks caused further losses to individual investors.
As retailers desperately needed liquidity but were having difficulty in getting new loans, a lot of property foreclosures were undertaken, which resulted in the sharp drop in the price of housing and new buildings. The 1929 crash lasted nearly 12 years.
Conclusion
The current speculative mania in the China and Hong Kong stock markets is quite alarming. While we believe that there may be some correction in the near future, hopefully, it will not turn out to be a major crash.
With the recent interest rate hikes and credit tightening measures, which may have caused some damage to the China economy, coupled with the slowdown in the US economy, we fear this may lead to the beginning of another great depression.
Disclaimer: Reading materials in this site are obtained from its respective website and it is for information purposes only. It is not Malaysia Unit Trusts - administrator view and it is not to be used against Malaysia Unit Trusts - administrator.
