Beating the Dead Horse: A Plain Jane Essay on the Most Overdone and Generic Topic in 20th Century United States History

"Had the economy been fundamentally sound in 1929 the effect of the great stock market crash might have been small. Alternatively, the shock to confidence and the loss of spending by those who were caught in the market might soon have worn off. But business in 1929 was not sound; on the contrary it was exceedingly fragile. It was vulnerable to the kind of blow it received from Wall Street …. Yet when a greenhouse succumbs to a hailstorm something more than a purely passive role is normally attributed to the storm. One must accord similar significance to the typhoon which blew out of lower Manhattan in October 1929." [1]

On October 24, 1929, the United States stock market suffered one of the largest crashes in history, in what would become known as “Black Thursday”. Stocks rebounded a bit on late Thursday and the following Friday, but plummeted on October 28, “Black Monday”, and plummeted again on October 29, “Black Tuesday.” The Crashes of 1929 were both a mark of all the problems in the financial system and the downturn that was occurring at the time, a harbinger of the coming Depression, and, ultimately, a catalyst of the bank crisis that accelerated the economic collapse and the financial reforms that would follow.

Although it played a significant role in initiating the bank crisis, the Crash of 1929 was in fact a result of the growing economic trends that were already in place, and that would eventually cause the economic collapse of the United States.

One of the most important contributing factors was the rapid deflation of currency, by which the increasingly productive American economy, especially relative to the struggling nations of war-torn Europe, had caused a deflationary spiral; the real value of American currency was increasing, and as such living costs in currency value were decreasing. While apparently a boon for consumers, who, theoretically, with lower commodity costs, would increasingly be willing to spend, this also led to a decrease in the real value of income, especially for those working in certain industries, such as agriculture. Additionally, deflation fostered both an unwillingness for prospective upstarts to take out loans, because deflation would mean that they would have to repay much more in terms of real value, and an unwillingness for financiers to invest into upstarts, because the risk involved would outweigh simply retaining currency. This economic trend was one allowed to mostly go unchecked, and even perpetuated, by national economic policy, because at the time the primary fear among economists was inflation, particularly after the experiences of WWI and its aftermath, and the rampant hyperinflation of the German Weimar Republic. Currency was allowed to trend toward deflation, and after the 1929 Crash, was even advanced by the contraction of the currency supply by the Federal Reserve.

The 1920’s was also a period of great economic success, and led to a heavy expansion of industrial capability and mass, automated production. At first, this fed directly into the fast-developing consumerist culture, producing luxury commodities, like automobiles and radios, that were widely available and at low cost. However, as deflation set in, industry only continued to expand, and soon industrial production had far outstripped the real value of wage increases. This, saddled with an oversaturation in many markets, created a situation in which industry was manufacturing a large volume of goods, but the financial conditions of many middle-class consumers limited the popular demand for them.

Thus by 1929, the economy had stagnated, with little investment by financiers to start up new ventures, and little willingness on consumers’ part to purchase the commodities that were being overproduced.

Despite all of this, stock market conditions in 1929 were rapidly bullish. Throughout the 1920s, a period of sustained economic growth had caused the market to soar, and stocks were seen as an extremely stable and without significant risk, an almost infallible market in which to ‘get rich quick.’ “Most investors never even thought a crash was possible. To them, the stock market ‘always went up’.”[2] This belief, shared not only by some economists of the era, but by the general public, created a speculative boom, as not only professional brokers, but everyone, down to working class individuals who knew nothing at all about investment, plunged their savings into the market, artificially driving prices up to a level far exceeding their real value. At the same time, banks eagerly lent money to investors, further fueling the stock speculation spree. Even Irving Fisher, perhaps the most well known economist of the time, remarked “Stock prices have reached what looks like a permanently high plateau”[3] only a week before the initial Black Thursday crash. The bursting of this artificial price bubble, and the crashes of October 1929, were all but inevitable.

Investors began to realize this in the early fall of 1929, when the stock market peaked. On October 24, 1929, “Black Thursday”, investors began to sell off their stocks, and a massive panic sale set in. By midday, however, several prominent bankers, such as Thomas Lamont of J.P. Morgan and Richard Whitney, vice-president of the New York Stock Exchange (NYSE) had worked to dissuade fears and restore investor confidence. Stocks rebounded slightly after the midday, and again on Friday. When the floor reopened on Monday October 28, and again on Tuesday, however, the general panic resumed, as everyone rushed to liquidate their assets and pull out of the market, all at once. Over just two days, October 28-29, the market plummeted nearly 25%, sparking a decline that would not bottom out until July of 1932, when the market remained at just 10.8% of its peak 1929 level.

“It came suddenly, and violently, after holders of stocks had been lulled into a sense of security by the rallies of Friday and Saturday. It was a country-wide collapse of open-market security values in which the declines established and the actual losses taken in dollars and cents were probably the most disastrous and far-reaching in the history of the Stock Exchange.”[4]

The most immediate effect was that on the investors. Almost all who had invested into the stock market were left penniless, and even the savviest investors met financial ruin, as the recession bucked all conventional market wisdom and only continued to worsen and worsen over the next three years.

"In the autumn of 1929 the New York Stock Exchange, under roughly its present constitution, was 112 years old. During this lifetime it had seen some difficult days. On 18 September 1873, the firm of Jay Cooke and Company failed, and, as a more or less direct result, so did fifty-seven other Stock Exchange firms in the next few weeks. On 23 October 1907, call money rates reached one hundred and twenty-five per cent in the panic of that year. On 16 September 1922 - the autumn months are the off-season in Wall Street - a bomb exploded in front of Morgan's next door, killing thirty people and injuring a hundred more.

A common feature of all these earlier troubles was that, having happened, they were over. The worst was reasonably recognizable as such. The singular feature of the great crash of 1929 was that the worst continued to worsen. What looked one day like the end proved on the next day to have been only the beginning. Nothing could have been more ingeniously designed to maximize the suffering, and also to ensure that as few as possible escaped the common misfortune. The fortunate speculator who had funds to answer the first margin call presently got another and equally urgent one, and if he met that there would still be another. In the end all the money he had was extracted from him and lost. The man with the smart money, who was safely out of the market when the first crash came, naturally went back in to pick up bargains. (Not only were a recorded 12,894,650 shares sold on 24 October; precisely the same number were bought.) The bargains then suffered a ruinous fall. Even the man who waited out all of October and all of November, who saw the volume of trading return to normal and saw Wall Street become as placid as a produce market, and who then bought common stocks would see their value drop to a third or a fourth of the purchase price in the next twenty-four months. The Coolidge bull market was a remarkable phenomenon. The ruthlessness of its liquidation was, in its own way, equally remarkable.”[5]

While a huge loss for investors, the crash of 1929, in and of itself, shouldn’t have been a major event outside of the investing world; it was simply an indicator of the gross overspeculation and misjudgment of real value. Were it not for a single important flaw in the financial structure of the stock market, ‘buying on margin’, the economy would have simply proceeded along, at a pace of gradual decline and recession, and perhaps one that in time could have been corrected through careful governmental management of the economy. However, it was this single fault which allowed the crash of the stock market to expand and engulf the rest of the financial order, striking at the heart of the banking system and plunging not only stock investors but businesses and middle/working class people who had never touched the stock market, along with them, and it was this single fault that rapidly accelerated the collapse of the U.S. economic structure and thrust the nation into the Great Depression.

The concept of ‘credit’ was largely introduced in the 1920s, whereby instead of paying for something entirely upfront with cash, people could pay with credit, paying an initial sum that was a fraction of the total price, and then paying the rest in periodic installments or some type of revolving credit scheme. In addition to overall economic prosperity, the credit system enabled many middle class consumers to purchase commodities, such as an automobile, and pay for it later. The same concept was applied to the stock market, in a practice termed “margin buying”. In margin buying, an investor would only need to pay a small fraction of the stock price (often around 10%), while the rest of the money would come from a loan through the bank. Because of the seemingly permanent prosperity of the stock market, both investors and banks invested heavily through margin buying, without restraint for consideration of risks, and the lack of significant regulation in the laissez-faire economic policy of the 1920s allowed the rampant lending for margin buying to severely undercapitalize many banks (i.e., leave them without adequate cash reserves).

Thus, when the market crashed, not only did investors lose all of their funds, but the vast majority of money lost (about 90% of it) was money that was lent by the bank to the investors. Thus, with their shares of stock virtually worthless, investors who had bought on margin almost universally defaulted on their loans, leaving the undercapitalized banks in a precarious position. This, simultaneously with the investor sell-off panic, triggered a sudden panic for everyone else, who were depositors in the very banks that had lent out all of their cash reserves to the investors, causing mass withdrawals of deposits. With the depositors’ money lost by the investors in the stock market crash, the banks had no cash reserves to back the sudden withdrawal of depositors’ money, causing widespread bank failures, and the complete loss of the personal savings of all depositors. Not only this, but the closings of banks also closed the lines of credits to many small businesses, who, especially without the backing of financiers, could barely function and were forced to close down, and even the largest and most secure corporations before the Crash were forced to drastically cut workers.

“… and by 1933 perhaps 15 million (no one knew exactly)—one-fourth or one-third of the labor force—were out of work. The Ford Motor Company, which in the spring of 1929 had employed 128,000 workers, was down to 37,000 by August of 1931. By the end of 1930, almost half the 280,000 textile mill workers in New England were out of work. Former President Calvin Coolidge commented with his customary wisdom: ‘When more and more people are thrown out of work, unemployment results.’”[6]

And thus, almost overnight, the stock market crash had purged away the wealth of not only the stock investors, but small businesses, anyone who worked for a small business, and virtually everyone who had deposited their personal savings into a bank, and had left them with nothing—not even with any means to regain that wealth or sustain themselves due to the massive unemployment. With a virtually impoverished consumer base, many Americans were barely able to sustain themselves, much less purchase luxury commodities. Compounded by a contraction of currency by the Federal Reserve, serving to increase deflation, and the Smoot-Hawley Act, which raised tariffs and effectively shut down all international trade, the economy was placed into a cyclical trend in which consumers refused or were unable to spend, and thus businesses had to cut employment, leading to less consumer purchasing power and even more unwillingness to spend, a trend that did not, as many economists had hoped, correct itself, eventually leading the United States into the Great Depression.

The legacy of the Crash of 1929, however, lies not in its role as a catalyst of the bank crisis and eventual depression, but in the numerous reforms that it spawned in response to the flaws in the financial structure that had caused it. Late in the Hoover administration, the first Glass-Steagall Act was introduced, which allowed the Federal Reserve to issue currency without a direct gold reserve to back it, a major tool in allowing the government to spur inflation. After Franklin Roosevelt took over as President, one of his administration’s first acts was to enact the second Glass-Steagall Act, also known as the Banking Act of 1933, a response to the widespread bank failures and the exposed vulnerabilities of the loosely regulated banking system. The second Glass-Steagall Act introduced the Federal Depositor Insurance Corporation, which would guarantee, to an extent, depositors’ money in a bank. The act also served to centralize much of the banking system, “… [authorizing] the president to appoint a new Board of Governors of the Federal Reserve System, placing control of interest rates and other money market policies at the federal level rather than with regional banks.”[7], and urging many large banks to join the Federal Reserve System, resulting in a much more tightly regulated—and secure—system. To halt the widespread corruption in the stock market, and halt the rampant overspeculation and margin investment by casual, uninformed investors, the Roosevelt administration also established the Securities and Exchange Commission (SEC) to enforce the Securities Act of 1933 and Securities Exchange Act of 1934. Specifically, the SEC was given the power to tightly regulate the ability of purchasing stock on the margin, restrict speculation by those with insider information, and to require disclosure of important financial information by publicly-traded businesses. Perhaps most importantly, the simple fact that the conditions brought upon by the Crash of 1929 caused any change was revolutionary in that it broke the popular mindset from the strict adherence to a laissez-faire economic policy, and opened up financial institutions to major policy reform and government regulation. Like the rest of the economic structure that preceded the Great Depression, the flaws in the financial structure of Wall Street, exposed and realized in the Crash of 1929 and subsequent depression, served to prompt significant reform in economic and financial policy.
Bibliography

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Galbraith, John Kenneth The Great Crash: 1929. New York: Houghton Mifflin, 1954

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“Stock Market Crash of 1929.” Stock Market Crash! Website <http://www.stock-market-crash.net/1929.htm>

"Stock Prices Slump $14,000,000,000 in Nation-Wide Stampede to Unload; Bankers to Support Market Today.” New York Times October 29, 1929, Front Page

U.S. Securities and Exchange Commission Website. <http://www.sec.gov>

Woodard, Dustin “Stock Market Crash of 1929.” About.com <http://mutualfunds.about.com/cs/1929marketcrash/a/black_tuesday.htm>

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[1] Galbraith p. 204

[2] Stock Market Crash! Website

[3] Woodard, “Black Monday”

[4] New York Times

[5] Galbraith p. 130

[6] Zinn p. 387

[7] Henretta p. 806