On October 24, 1929 (“Black Thursday”) the United States equity markets had the most dramatic decline in their history. Over the course of four days, the Dow Jones Industrial Average fell 25%. Investors lost $30 billion, or the equivalent to $400 billion in 2017. The real story goes beyond the numbers. The crash of 1929 was a lesson in reckless speculation, poor monetary policy, and moral hazard.
Leading Up to the Crash
The 1920’s experienced a remarkable bull market. From 1924 to 1929, the DJIA more than quadrupled and, for the first time, investing in public stocks was mainstream in the United States. Banks quickly loaned money to investors instead of homeowners or entrepreneurs. After all, the stock market looked more secure than the housing or job market. By early 1929, 40% of bank loans went to finance stock market purchases.
Even if the stock market crashed, the newly created Federal Reserve could bail out the banks. Bank loans exploded under the guidance of Benjamin Strong, the governor of the New York Fed Bank and quasi-autocratic ruler of the early Federal Reserve system. Because Strong was worried that Herbert Hoover’s protective tariffs would shut out foreign consumers, he encouraged American lenders to bankroll buyers outside the country.
Strong was also friendly with the British monetary authorities. Britain suffered greatly during World War I, and London begged the United States to devalue the U.S. dollar in order to help out a weak pound sterling. Beginning in 1924, the Federal Reserve inflated the money supply to drive down the dollar. Most of that new money found its way into the stock market. (Read more here.)
Stock market trading in the late 1920’s would be very unfamiliar to modern investors. Trades processed and recorded through telegraphs and ticker tape machines, although impressive for their time, could not handle huge trade volume over short stretches. Business and investment news trickled out relatively slowly—most investors made trades based on the prior day’s newspaper.
In the week leading up to Black Thursday, newspapers around the country spread worry about margin trading and reckless stock valuations. Reports from Britain’s Chancellor of the Exchequer Phillip Snowden indicated that the U.S. stock market was far too speculative. Prominent American journalists quickly agreed. On Wednesday, October 23, the papers warned of a coming crash and the doom of the stock market.
Details of the Crash
The next day, 12,894,650 shares traded on the exchange, shattering the old record of 3,875,910 (set March 12, 1928). This huge volume put stresses on the communication and information systems at the NYSE, which only fueled panic among investors. Tickers were hours behind the actual trade requests, and nobody knew what would happen.
Rowdy crowds gathered outside the stock exchange. The phone systems rang non-stop. Frustrated, the investors tried to storm the exchange but were only turned back after New York police showed up to control the riot.
The financial establishment didn’t go down without a fight. Investment companies and prominent bankers bought up large chunks of stocks on Friday to stabilize the market. Experts hoped that a rally into the weekend would calm down the rest of the country. It didn’t.
The following Monday and Tuesday saw enormous losses. 16,410,030 shares traded on Tuesday, wiping out billions. Major U.S. corporations like U.S. Steel and General Electric saw tumbling prices. There is an urban legend that the opening bell on October 28 was never heard because it was drowned out by chants of “Sell! Sell!” False rumors broke that investors were jumping out of windows, which only intensified the panic.
The large number of selloffs put a panic on the financial system. Much of the stock market’s value was built on borrowed money (margin accounts), which meant that the banks’ balance sheets were extremely vulnerable to a downturn. When stocks lost too much money, margin calls knocked out investors. Those investors could no longer pay back their bank loans.
There’s another important factor to consider: Benjamin Strong, architect of the Fed inflation of the 1920s and strong friend to the banking industry, died late in 1928. His successor, George Harrison, seemed much less inclined to print money and save banks that made risky loans. In fact, Harrison worried that Strong’s inflationary policies had pushed interest rates too low and made it too easy to borrow money on speculative projects. He raised the discount rate to 6% in August 1929.
So the banks levered up their books on the premise that Strong would bail them out, but Strong was gone by the time the crash came. Harrison tried to unwind the mess by raising rates, but to no avail.
Lessons from the Crash of 1929
Many historians and economic scholars point to this massive selloff as the beginning of the Great Depression.
The Great Depression of the 1930s was not only the longest-lasting depression in modern history, but it was also the steepest. Prior crashes, regardless of their cause, only lasted (at most) one or two years. The forgotten depression of 1920-21, less than a decade before the onset of the Great Depression, lasted less than 20 months. Things were different in the 1930’s. Between 1931 and 1940, unemployment never dropped below 14.2%, and it was as high as 24.75% in 1933.
The stock market crash of 1929 exemplified what economists call “moral hazard.” American industrialists, particularly the well-connected banking elite, felt confident that their balance sheets were covered by the young Federal Reserve. After all, the Fed sprang from the minor banking panics of the 1890’s and early 1900’s, and the economy seemed to hum along under its guidance.
Unfortunately, the Fed made it too easy for banks to ignore good underwriting standards. They also made it too cheap to borrow money, which meant speculative projects were more accessible to those without the skill to see them through. In turn, investors turned away from traditional savings habits—low debt, slow-growing retirement funds, and precious metals—in favor of dangerous ones.
It does not look like the Federal Reserve or the U.S. government learned the lessons of history. The Fed has only recently left its experimental zero-interest rate policy, and the government has already shown major investment banks that it will bail them out if they get into too much trouble. As a result, we’ve seen record stock market prices in 2016 and 2017, even though business profits do not seem to justify those stock prices.
Investors don’t have to repeat the mistakes of the past, however. If you are interested in protecting your portfolio from government debt, stock market bubbles, and Fed-driven inflation, talk to American Bullion about opening up a Gold IRA.
American Bullion can discuss your options and help you every step of the way. Our #1 goal is to help you take control of your own finances, and we promise to be transparent, safe, and efficient in the process.
Although the information in this commentary has been obtained from sources believed to be reliable, American Bullion does not guarantee its accuracy and such information may be incomplete or condensed. The opinions expressed are subject to change without notice. American Bullion will not be liable for any errors or omissions in this information nor for the availability of this information. All content provided on this blog is for informational purposes only and should not be used to make buy or sell decisions for any type of precious metals.