The “War Bubble” and the Russo-Japanese War
Bryan Taylor, Chief Economist, Global Financial Data
The Russo-Japanese War was the first victory of Japan over a European country and led to a stock market bubble in Japan. War bubbles frequently occur when a country wins a victory that investors expect will lead to further development of the economy, but when investors overestimate the impact of the victory, the market can crash. Russia’s defeat in the war led to a failed revolution and stock market crash in Russia. After the revolution following World War I, Russia became a Communist country that closed the stock market for the next 74 years.
The Russo-Japanese War
After the Meiji Restoration in 1868, Japan assimilated western ideas and expanded their empire until its defeat in World War II. The First Sino-Japanese War of 1894-1895 was fought over control and influence in Korea. Japan was victorious in the war and Japan gained control over Taiwan after the war. As can be seen in Figure 1, Japan’s victory led to a bull market during which the Japanese stock market doubled in price between 1891 and 1896, then lost one-third of its value between 1896 and 1901.
Figure 1. Japanese Stock Market Index, 1890 to 1945
The Russo-Japanese War was fought over influence in Korea and Manchuria. Japan wanted its influence over Korea to be recognized in exchange for recognizing Russian influence in Manchuria. The Russians refused and the Imperial Japanese Navy launched a surprise attack on the Russian Fleet at Port Arthur on February 9, 1904. The Russian Empire responded by declaring war on Japan. Despite suffering a number of defeats, Emperor Nicholas II was convinced that Russia could win the war. Russia ignored Japan’s willingness to agree to an armistice, and after defeat in the battle of Tsushima, the war ended with the Treaty of Portsmouth on September 5, 1905, which was mediated by President Theodore Roosevelt. Encouraged by their victory, Japan annexed Korea in 1910, invaded Manchuria in the 1930s and spread their empire throughout the Pacific in the 1940s before being defeated in World War II.
The Japanese stock market rose 25% between the surprise attack on Port Arthur and the Treaty of Portsmouth, but after the Treaty was signed, the stock market rallied dramatically, rising 90% between September 1905 and January 1907. Bank of Japan stock rose from a low of 415 in 1905 to 1000 by December 1906. Tokyo Stock Exchange shares rose from 141.5 in 1905 to 750 by January 1907 and Osaka Stock Exchange shares rose from 137.5 to 774.9. Stock exchange shares were the best performing stocks in Japan during the bull market.
Between 1901 and January 1907, stocks increased in price by 138%, but then declined by 64% by the end of 1914, ending up below where the stock market had been in 1901. As is illustrated in Figure 1, the Japanese stock market went through an inflation-fed rally during World War I, during which it recovered to the heights of the 1906 market bubble, only to crash during the world-wide recession that followed World War I. If you adjust the Japanese stock market for inflation, you can see that Japanese investors were unable to keep up with consumer price increases during the first half of the twentieth century. Figure 2 shows that Japanese stocks failed to keep up with inflation despite the rallies during the Russo-Japanese War, World War I and World War II.
Figure 2. Japanese Stock Market Index adjusted for Inflation, 1890 to 1945
War bubbles are not uncommon. A similar bubble occurred in Germany when Germany defeated France in the Franco-Prussian war in 1870. The victory was followed by the unification of Germany under Prussia, a large war indemnity, the introduction of the Gold Standard and the German Mark resulting in a stock market bubble that occurred in both Germany and Austria. Both markets creashed in 1873. The similarity between the “war bubbles” of Germany in 1870-1874 and Japan in 1904-1908 is striking as a comparison of Figure 1 and Figure 3 shows.
Figure 3. Germany Stock Market Index, 1860 to 1880
A similar war bubble occurred in Denmark during World War I. Denmark was neutral during World War I and was able to provide shipping services to countries involved in World War I. This led to a large increase in the profitability of and dividends paid by shipping companies creating a large increase in the price of Danish shipping stocks. When World War I ended, the demand for Danish shipping ended, and both the profitability of Danish shipping and their stocks declined as is illustrated in Figure 4.
Figure 4. Danish Shipping Stocks, 1910 to 1932
The impact on Russia of the Russo-Japanese War was quite the opposite of the impact on Japan. Not only did Russia suffer a humiliating defeat at the hands of the Japanese, but they lost control of the lower portion of the Sakhalin peninsula until it was restored after World War II. Russia’s defeat led directly to the Russian Revolution of 1905. The Russian government issued a Manifesto on October 17, 1905, granting reforms to the population including a State Duma. A new Russian Constitution was introduced in 1906; however, the Tsar ultimately held power over the Duma and during the Russian Revolution of 1917, the Tsar was overthrown.
Figure 5. Russia Stock Price Index, 1890 to 1915
Figure 5 illustrates the behavior of the Russian stock market between 1890 and 1915. The stock market hit a peak in 1895 and began its downward slide in 1899. The stock market stabilized after 1900, but began a second decline in 1904, hitting a bottom in August 1906 after the reforms of the Russian Revolution were introduced. The Russian stock market lost almost half of its value between 1895 and 1906. The market began to rally in 1908 and rose by 155% by 1914. Although the Russian economy had not grown between 1902 and 1906, Russian GDP grew by an estimated 60% between 1906 and 1913. When World War I began in August 1914, Russia fell into a downward spiral which ended with the overthrow of the Tsar in 1917 and the victory of the Communists over the provisional Kerensky government.
Conclusion
The performance of the Japanese and Russian stock markets reflected the results of the Russo-Japanese War. The Japanese stock market went through a bubble between 1904 and 1908, more than doubling in price before giving back all of its gains in the bear market that followed the War. The performance of the Japanese stock market mirrored the performance of the German stock market when Germany proved victorious in the Franco-Prussian War of 1870 which led to the establishment of Germany as a country and the adoption of the Mark and the Gold Standard. Both Germany and Japan enjoyed “war bubbles” as a result of their victories, but they both suffered defeat during World War II and their stock markets declined by almost 90% as a result.
The Russian stock market declined during the Russo-Japanese War and the Revolution of 1905 that followed. The stock market recovered between 1908 and 1914, but when World War I began, the St. Petersburg stock exchange closed, reopened briefly in 1917, then was closed by the Communists after the Tsar was overthrown. The Russian stock market did not reopen until 1991.
The “war bubbles” of Germany in 1870 and Japan in 1905 reflected the short-term enthusiasm produced by their military victories, but once the wars were over, life returned to normal and the stock market deflated. Even when stock markets benefit from war, the impact is fleeting.
