The Economic Causes and Impacts of the Stock Market Crash of 1929 (Fall 2012)

Once I read, “If you want to do well in Finance, study the history.” As a Finance student, the origins of the Great Depression have always puzzled me. I believe that there is so much to learn from this incident in order to prevent from reoccurrences of potential financial downfalls. The great depression was the longest and most severe economic depression ever experienced by the industrialized Western world. The timing of the depression varied across the countries, but it mostly occurred in the 30’s and 40’s of 20th century. Even though the depression was relatively mild in some countries, it was severe in others, particularly in the United States, where it was originated.

After World War I, the United States had become the major creditor and financier of postwar European countries, whose national economies had been greatly weakened by the war itself, by war debts, and, by the need to pay war reparations. So, once the American economy weakened and the flow of American investment credits to Europe stopped, prosperity tended to collapse there as well. The Depression hit hardest those nations that were most deeply indebted to the United States such as Germany and Great Britain. The end of World War I brought a new era in the United States. It was a time of enthusiasm, confidence, and optimism, and people believed in infinite possibilities. They were taking their savings out and invest it to build new technologies and new inventions( ). Even though, there is no agreed upon listed causes of the depression, the stock market collapse of 1929 was its biggest reason.

It all started with the stock market collapse

In the 1920s, many invested in the stock market, which seemed an infallible investment in the future. As more people invested in the stock market, stock prices began to rise. Stock prices went up and down throughout 1925 and 1926. This flow followed by a sharp upward trend in 1927 and enticed many more people to invest causing the boom to begin by 1928. The stock market boom changed the way investors viewed the stock market – it had become a place where people believed they could get rich quickly. The stock market no longer was for long-term investment. Stocks had become the conversation topic for everyone in everywhere because ordinary people were able to make millions off of it. Although an increasing number of people wanted to buy stocks, not everyone had the money to do so. That was when “Buying on Margin” concept came in to play. When someone did not have the money to pay the full price of stocks, they could buy stocks "on margin." That means that they would put down some of their own money, but the rest would be borrowed from a broker. Buying on margin is risky: if the price of stock falls lower than the loan amount, the broker will likely issue a "margin call," and the buyer must come up with the cash to pay back the loan immediately.

In the 1920s, the investors only had to put down 10 to 20 percent of their own money and thus borrowed 80 to 90 percent of the cost of the stock. Therefore, so many speculators bought stocks on margin and neglected the risks that came with it due to the never-ending rise in stock prices. The profits from trading seemed so assured that even many companies and some banks placed their customers' money in the stock market. With the stock market prices upward bound, everything seemed so wonderful. When the great crash hit, everyone was taken by surprise.

However, there were early signs of the crash. Five days before the incident, stock prices tumbled and a large number of people were selling their stocks. Margin calls from banks were sent out to borrowers. Across the country, people were closely following the rises and falls of the stock tickers. A crowd of people gathered outside of the New York Stock Exchange on Wall Street, and rumors circulated of people committing suicide. Things got intense and stressful on the market. Following afternoon, several banks pooled their money and invested into stock market to convince investors to stop selling their stocks, which actually gave some relief to many and the subsided the panic that the public had( ). However, it was not enough to stop the danger.

October 29 of 1929, so called “Black Tuesday” was the day. This is the worst single day in stock market history. People were in a panic and rushed to sell all the stocks they had in hand. Since everyone was selling and no one was buying, stock price collapsed. Even banks started selling the stock they had. Panic hit the country and over 16.4 million shares of stock were sold in one day. It continued for the next days, and the price kept dropping. In fact, the drop continued over the next two years. On that particular day, the market lost $14billion in value, following more than $30billion in the week, - ten times more than the entire annual budget of the Federal Government and far more than what the US had spent during the World War I( ). Thousands of individual investors who believed they could get rich by investing on margin lost everything they had, their life savings, their houses and their dreams. The sock market crash severely impacted American economy.

The market crash led to bank failures nationwide

Since many banks had also invested large portions of their clients' savings in the stock market, these banks were forced to close when the stock market crashed. The bank closures caused another panic across the country. Afraid to lose more money, people rushed to banks that were still open to withdraw their savings that they kept out of the stock market. This massive cash withdrawal caused additional banks to close. Throughout the 1930s, over 9,000 banks failed ( ). Bank deposits were uninsured and thus as banks failed people simply lost their savings. Surviving banks stopped issuing new loans due to uncertainty of the economic situation and the concern of their own survival. There was trust in the market. There was no hope in the people. Millions of people lost their savings once the banks closed. It damaged the economy even more after the stock market collapse.

Weakened economy reduced consumption

After the stock market crash and the bank closures, people were too afraid to lose more money. Due to the fears of further economic woes, individuals from all classes stopped purchasing and consuming. This freeze in the market led to a big reduction in the number of items produced and thus a reduction in the workforce. Businesses, industries, and individuals all were also affected. Many businesses started cutting back their workers' hours or wages to spend less. The lack of consumer spending caused additional businesses to cut back wages and to lay off some of their workers. Some businesses couldn't stay open even with these cuts and soon closed their doors, leaving more people unemployed. Too many people lost their savings, so many banks failed, and many factories shut down. The country was in a danger.

The USA faced its biggest economic challenge as a nation

By 1932, farm income fell some 50 percent, one out of every four Americans was unemployed, and 37% of percent of all nonfarm workers were completely out of work. People were starving; they lost their farms and homes ( ).The one of the youngest and the most powerful countries in the world faced its biggest crisis as a nation. And it was challenged its fundamental of free market. This was a country that was made up of immigrants and their positivism. Something could never crash if it was on the ground. Was America might have been higher than where it was supposed to be? Was America just an idea of some positive people that could be crashed in one storm? Was it the end of American dream?

America showed its power to the world by defeating the crisis

It took a decade and a half to fully recover the American economy from this worst. President Franklin Roosevelt, who was newly elected after the collapse started, is believed to be the one who rescued the country out of the crisis. He worked hard to bring back the confidence and optimism to the people of America. President Roosevelt stated in his inaugural address to the nation: “This great nation will endure as it has endured, will revive, and will prosper. This nation asks for action and action now. The only thing we have to fear is fear itself” He introduced his program, known as the New Deal, which consisted of the three R's: relief, recovery, and reform, and fought with the crisis aggressively.

World War II provided the stimulus that brought the American economy out of the Great Depression. Due to the war need, the number of unemployed workers declined by 7,050,000 between 1940 and 1943, but the number in military service rose by 8,590,000( ). The American economy had yet to fully recover from the Great Depression when the United States was drawn into World War II in December 1941. It took several more years several more years to fully recover. This crisis has taught many critical lessons to the generations to come, and there is still so much to learn more it. Numerous regulations regarding buying stocks on margin and the roles of banks in clients’ savings have created to prevent another severe crash could never happen again.

Sources

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