The 1929 Wall Street Crash
What happened and what does it mean for us today?
Communist dictator Vladimir Lenin once said that ‘there are decades where nothing happens and there are weeks where decades happen.’
It’s fair to say that the past few weeks belong in the latter category. In less than a month, many countries around the world have morphed from normal life into total lockdown.
Borders are closing, flights have been cancelled and people are even being arrested by dystopian policemen in hazmat suits.
The stock market hasn’t been immune from this chaos either. Since the start of this year, the FTSE 100 has lost 32 per cent of its value.
Looking to the past
Of course, this is not the first time that the stock market has crashed. Most Freetraders will remember the events of 2008 and the economic downturn that followed.
But the past couple of months have seen some of the worst one-day declines in the value of the stock market in history.
All sorts of comparisons are being made but the ‘go-to’ market crash for finance geeks tends to be the most famous — the 1929 Wall Street Crash.
And as we too have a nerdy penchant for finance history, we thought it would be fun to have a look at what caused it and what happened afterwards.
The Roaring Twenties
Like all great plunges in the stock market, the Wall Street Crash took place after a long period of economic growth and unbridled optimism.
From 1921 to 1929, the Dow Jones Industrial Average, a stock market index that tracks the 30 largest companies on US stock markets, increased in value six-fold.
In the US, unemployment was low at around 3 per cent, the automobile industry boomed as car-ownership increased three-fold and 50 million people a week, equivalent to half the country’s population, were going to watch a movie.
America’s success was mirrored in much of the Western World.
Economic prosperity saw Paris, London and Berlin blossom into cultural powerhouses. New forms of music, film, literature and art boomed in what we often call the ‘Roaring Twenties.’
What happened?
On Thursday, October 24th 1929, US investors began to sell off their stocks en masse. The Dow dropped by 9 per cent as trading volumes surged to three times their daily average.
Wall Street banks attempted to stymie the effects of the sell-off by buying up large amounts of stock. It didn’t work.
The Dow did recover a little the following day, rising by 0.6 per cent. But in the week that followed, it tanked again.
On what is now known as Black Monday, the market shrunk by 12.8 per cent. The day afterwards, imaginatively known as Black Tuesday, it dropped by another 11.7 per cent.
There have only been such large-scale, single-day drops in the Dow on three other occasions. Once in 1914, when it dropped 23.52 per cent, and in 1987 when it fell by 22.61 per cent.
The third occasion came on March 16th of this year when the Dow fell by 12.93 per cent in one day.
What went wrong?
Historians and economists are still debating what caused the Wall Street Crash but there are a few factors that are generally thought to have contributed to it.
The first is that the stock market was thought to be massively overvalued. US equity markets increased in value by an average of 20 per cent per year from 1922–1929.
This meteoric rise was increasingly thought to be unsustainable. Although it’s often depicted as having happened suddenly, the Dow had dropped in value by 30 per cent in the month prior to the crash.
As this was happening, the press spooked the public by reporting that foreign investors were exiting the market and short sellers were ramping up their operations.
The day prior to the crash, for example, the New York Times had ‘Prices of Stocks Crash in Heavy Liquidation’ as its headline.
Aside from panic-selling and over-valuations, many investors were also heavily indebted from buying on margin.
As the market was booming, banks were happy to lend out money (sound familiar?) to investors that they could use to buy stocks. Investors would only have to put down 10 per cent of the value of the loan and could use it to buy stocks.
This 10 per cent is usually referred to as ‘margin.’ The positive side of margin is that you stand to make more than you otherwise would using a smaller amount of money. This is known as ‘leverage,’ something that today is commonly associated with CFD trading.
But the reverse is also true — trading with margin means you can lose substantially more than you would if stocks crash. In fact, you can lose more than you had to begin with and the banks will be chasing you for money.
And that’s exactly what happened in 1929. The market crashed so quickly that investors could not sell off their stocks to pay back their loans, leaving them — and the banks that financed them — with big losses and huge debts.
The aftermath
The decade following the Wall Street Crash is often known as the Great Depression.
High unemployment, banking crises and a general sense of turmoil would permeate the lives of people across the globe, exemplified in John Steinbeck’s 1939 classic, ‘The Grapes of Wrath.’
Common wisdom often links together the Wall Street Crash and the Great Depression, with the former seen as inevitably leading to the latter.
But many economists and historians have argued that it was not the crash itself, but governments *response* to the crash that led to the depression.
After the crash, public opinion, usually driven by mass media, was that something ‘had to be done’ to undo the negative impact the crash had on the economy.
This ultimately led to high tariffs, protectionism and other high-level forms of government intervention in the economy across the globe.
Many economists now argue that these actions, and not the crash itself, were the main cause of the Great Depression.
The economist Thomas Sowell, for example, has pointed out that US unemployment peaked at 9 per cent following the crash but dropped back down to 6 per cent within 12 months. After interventionist policies were pursued in 1930, unemployment rose to nearly 25 per cent.
What happened to the markets?
It would take almost thirty years for the US stock market to reach the same levels that it had in 1929.
In the decade that followed the crash, growth was haphazard and the markets struggled to recover.
Ultimately, it was the Second World War which helped spur on American growth.
The US entered the war later than most of its allies and its distance from most conflict zones meant it emerged from the fighting the least-scathed and best positioned to lead the global economy — a position it arguably still holds today.
What does it mean for us?
Historians, economists and finance geeks have a habit of looking back at past crashes to deal with new ones.
There is some logic to this. We can learn from the past and apply that knowledge to deal with problems in the present.
The danger in doing this is captured by that old financial adage: Past performance is not a reliable indicator of future results.
Every crisis has its own nuances and preparing for the next one by looking at the last one may leave you ill-equipped to deal with a new set of challenges.
Media figures and members of the financial Twitterati are currently injecting a never-ending stream of past comparisons into the public discourse, hoping to deal with the problems brought about by the coronavirus today.
Some of this may be helpful but it might also be totally meaningless in the context of a pandemic.
Ultimately, no one really knows what’s going to happen. The best option is to stay safe, informed and not be overwhelmed by the deluge of information coming our way.
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