We've two different comparisons going on over the collapse in China's stock markets and the similarities with the Great Crash on Wall Street in 1929. One of those comparisons looks fair enough, we've an event of a comparable size. Although that doesn't mean that there will necessarily be a Depression in China as a result: that depends on what the government and central bank do next. The other comparison is a little more flakey: you need to believe in chartism, the technical analysis of stock prices, to get it. I don't so I'm not buying that second comparison.
But here it is anyway:
Chinese stocks will decline by an additional 14 percent over the next three weeks as the market demonstrates a trading pattern that mimics that of the U.S. crash in 1929, according to Tom DeMark, who predicted the bottom of the Shanghai Composite Index in 2013.
The benchmark for mainland stocks will sink to 3,200 after plunging 8.5 percent Monday to 3,725.56 in the worst selloff in eight years, DeMark said on Monday. That would extend its decline since a June 12 peak to 38 percent. The gauge’s moves since March are tracking those of the Dow Jones Industrial Average in 1929 when the gauge lost as much as 48 percent, he said.
There's no particular reason that Chinese investors in 2015 should react the way that American investors did in 1929. But if people want to believe that there are then obviously they're entirely free to do so.
However, there is another method of comparison that I think does hold water. Which is over the size of the event. As Dean Baker continually points out about the US housing collapse there's no way that the country wasn't going to have a recession as a result. Whether the financial system fell over or not was interesting, of course it was, but there would have been a recession without it nearly happening anyway. The reason is something called the "wealth effect". The more our assets are worth the wealthier we feel. Logically, because the value of our assets is our wealth. However, most of us, most of the time, when we feel wealthier we spend more money. And when we feel less wealthy we spend less. That is, a fall in asset prices leads to a fall in aggregate demand: recession here we come.
That housing bust wiped some $8 trillion off US household wealth. Roughly, that's around 50% of GDP at the time.
What's the size of this stock market fall?
Since early July, the Chinese government has resorted to measures aimed at stemming the slide in stocks that had wiped out roughly $3 trillion in market value in just three weeks beginning in mid-June. The steps, including a stock-purchasing program financed by the country’s central bank and commercial banks and a halt to new stock listings, helped restore some calm in the following weeks.
Add the recent slide and we might be talking about $4 trillion in wealth vanishing in a puff of smoke. China's total GDP (nominal exchange rate, the right thing to be using here) is around $10 trillion so we're in the same sort of ball park as that 50% of US GDP lost in the housing crash.
We're also around and about those US 1929 figures. GDP at the time was a shade over $100 billion, the October fall in the stock market was about $50 billion. The full fall, the final turn of the bear market, was in July 1932 by which time it had fallen $125 billion or so. More than annual GDP which is obviously a significant wealth effect for the economy to have to deal with.
So, if China's stock market keeps on tanking is the country condemned to another Great Depression? No: Baker is right that this will obviously cause a recession (which in China, given the country's growth rate recently, might mean that the economy continues to grow but just not at the 7 and 8% of recent decades) but that doesn't mean a depression.
For as Milton Friedman and Anna Schwartz pointed out, it wasn't the Crash that caused the Depression. It was what everyone did next that did. Some of the blame needs to go to Roosevelt and things like the National Recovery Administration (no, seriously, price fixing just doesn't work) but the major blame needs to go to the Federal Reserve and their allowing the money supply to shrink grievously. As Ben Bernanke actually said when he stated that Milton had got it right, we did it and we're not going to do it again. Which they didn't.
So, there are indeed parallels with the 1929 Crash here, we're seeing a wealth effect of a similar sort of size in relation to the economy. And we'd expect to see a recession as a result (as above, this might mean Chinese growth of only 1 or 2%, instead of actual shrinkage) but this doesn't mean that there will be a Depression. That all depends upon what people do next.
