The Future of the Chinese Stock Market: A Comparison of China Today vs the Japanese Market in 1989

Our Crash Alert flag is still fluttering outside.

You’ll recall that it was hoisted up there about three months ago. For a long time, it looked silly. Who needs a ‘Crash Alert’ when the world is booming?

But just yesterday, as we were writing about the threat posed by collapsing Chinese stock prices, it turned out that Chinese stock prices were…in the process of collapsing. Some stocks were down to the limit in Shanghai and Shenzhen. The markets ended the day down almost 10% – the biggest drop in 10 years.

Other emerging markets fell too, emulating the Chinese example. And then, when the tsunami got to New York, U.S. stocks were soaked too. The Dow was down more than 500 points at one time during the trading day – the biggest hit since 9/11.

And look at what is happening to the financial stocks. Yes, even Goldman Sachs (NYSE: GS) seems to have topped out – a company run by the smartest financiers in the business…perched on the biggest financial bubble of all time.

Does this mean the Chinese bubble is finally popping? And if so, does that mean that the whole enchilada…the whole worldwide liquidity bubble…is finally going to blow up? We’ll have to wait and see.

But we remind readers that the many lurking threats to their money are not all equal: Some are unpredictable…and others are unavoidable. Among those that are unforeseeable are war and natural disasters. Among those that are ineluctable are the popping of the credit bubble…and the destruction of the U.S. dollar.

The first challenge for investors is merely to recognize the difference, for different sorts of threats require different responses. The second challenge for investors is to recognize the different ways the market can do damage to them: While they might lose a lot of money ignoring inevitable threats…they could also lose a lot of money chasing inevitable opportunities.

On the good side, when you speculate on the inevitable, at least you are on the right side of the trade. But, on the bad side, whether you make money or lose will depend on your timing. “The market can stay irrational longer than you can stay solvent,” said Lord Keynes. So, sometimes, it is better not to try to trade a trend – even if it is inevitable. Just get in position so it won’t do you any harm. You may not get rich, but you’ll still be better off than most investors.

On the other hand, there are some who say you should just ignore inevitable threats in order to take advantage of the inevitable opportunities that usually go along with them.

“Yes, I agree, the Chinese market is going to take a tumble. It’s inevitable,” said our friend last weekend. “But over the long term – and I’m talking about 10 years or more – China is going to boom. I want to be a part of that boom. I want to be in it. So, I’m willing to take some discomfort in the short term in order to participate in the longer-term gains.”

We think our friend is an optimist. By way of rebutting him, we call two witnesses. Our first is the Ghost of ’29. No economy was more successful in the 20th century than the United States. And never was it more successful than in the ’20s. America…and America alone…emerged from World War I as the clear winner. The rest of the world owed it money. Its industries were booming. Its stocks were soaring. Its young and inventive hard-working people were creating new technologies and building new factories and skyscrapers. Europeans returned from visits to New York in the ’20s like Americans now return from Shanghai. The pace…the excitement…the commercial activity…the liveliness…the energy – it was overwhelming. They could scarcely believe their eyes. Many wanted a piece of it.

Over the long run, a European investing on Wall Street might do fairly well. But what if he had invested in the late ’20s, when America’s promise and success seemed most inevitable? Just ask the Ghost of ’29. If he had invested his money just before the crash, he would have had to wait until ’56 to break even! That is, he would have had to hold on through a Great Depression…another major world war…and practically until the end of the Eisenhower administration – a period of 27 years! After that, he would have enjoyed a good 10 years of capital growth – and then another setback.

Our other witness is still living; he can speak for himself:

We started by asking him, “Isn’t it true that Japan was the greatest success story of the post-war period?”

“Yes…I believe that is correct.”

“Isn’t it also true that the Japanese made their money by selling goods and services to Americans? Isn’t it true that they realized huge foreign trade surpluses in this manner – similar to what the Chinese are doing now? And didn’t they build up huge foreign currency reserves? And didn’t the Japanese economy boom…especially after the Louvre agreement, when they tried to keep their currency low by reducing interest rates and increasing liquidity – very similar to the Chinese example now, in fact? And weren’t investors so excited by the prospect of getting rich in Japanese stocks – and I think this includes you – that they rushed into the Tokyo market? And didn’t Japanese stocks and real estate reach an epic, zany high in January of 1989?”

“Yes, all that is true.”

“Then would you mind telling us, in your own words, what happened after you bought Japanese stocks in January of 1989?”

“Not at all. It is very simple. The Nikkei index was over 39,000 when I bought. Shortly thereafter it crashed. I didn’t worry about it, because I was investing for the long term. And over the long term I believed Japan would do well. It was, well, inevitable. I had read the papers. I also read a few of those books about how smart the Japanese were and how their management techniques were superior to those of Americans.

So, it seemed to me that betting on Japan was a no-brainer. But that was in ’89. Then, when the Nikkei got down to 8,000, I began to have second thoughts. And then, when it didn’t bounce back I had third thoughts…and fourth thoughts. Japanese stocks stayed down for the next 15 years. They’re only starting to come back now. The Nikkei is now back to almost 20,000. It’s in all the papers that Japanese stocks are at a 15-year high. But wait a minute, I’m still out half my money. Let’s face it. I may be dead before I get my money back.”

“Thank you…no more questions.”

Look up. The Crash Alert flag still flies. Oh, long may it waver…

Bill Bonner
Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.
Bill Bonner

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