Free «The Stock Market Crash of 1929» Essay Sample

In the past, the US had experienced similar collapses to the one of 1929, though on somewhat smaller scale (Samuelson). The paper will describe the crisis of 1929 and will try to explain why the stock market collapse escalated into the Great Depression this time.

In the 20s the US economy was on the rise, for the period from 1925 to 1929. GDP grew by 14.3% from 90.5 to 103.6 billion dollars. There were new, “innovative” types of goods such as cars, radio, airplanes, and so on. The growth of the economy increased the volume of savings, which also had a positive impact on the development of the stock market. From 1925 to 1929 stock market capitalization increased by approximately 3.3 times – from 27 to 89 billion dollars. In 1929 it reached almost 86% of GDP. Inflation has not been a significant price index (100% in 1947) for 1927-1929, it amounted to 74.2, 73.3, 73.3, respectively. Fed pursued a “soft” monetary policy, the discount rate for the period from 1921 to 1927 decreased from 6.5% to 4.0%.

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The economic ideology of the time was dominated by the doctrine of “laissez faire”, which postulates that market forces have unlimited opportunities for self-regulation. Monetary authorities have not been able to enter into normal framework uncontrolled development of the stock market. Available margin collateral was about 10%, i.e., with 90% of the purchased shares a new loan could be taken. Growth contributed to speculation with affordable interest rate on the loans, which amounted to about 12% of brokers. Investors were building “pyramids”: they bought shares on the mortgage in order to buy new shares, etc. While quotes were going high, such strategy allowed obtaining a good income. (Pettinger). Some of the shares were in fact “dummy”, not secured by real assets. By some estimates, the number of margin accounts ranged from 0.6 to 1.0 million, the total number of brokerage was around 1.5 million.

At the same time, investment companies began to actively emerge to buy shares using shareholders funds. Massively adopted price manipulation and collusion between speculators inflated prices on the securities, which they needed relying on the powerful information and financial support. At the same time, the ratio of P / E (price / earnings) for the most companies was normal, making about 14-19 of shares in the different groups in 1929.

The scheme was the following: share valued at $ 1,000, you can buy it for $ 100, the rest of money could be paid by installments plan. This scheme made stocks market accessible for poor people, but it had a dangerous flaw. At any time broker could require the payment of a debt, which made it necessary to sell the stock, and this sale could easily turn into a snowballing process. Citizens were obsessed with getting rich quick, they invested all their savings in shares of corporations to subsequently sell them more expensively. (Timberlake). Using of risky instruments should be careful deal, remembering that the poison is different from the drug only by one feature – a dose.

Since the early 20s, Federal Reserve System (Fed) pursued a policy of increasing the monetary supply, and the government was about to reduce taxes. (Lopus). This has led to the development of entrepreneurship and real growth of the economy. But in 1928, the Fed suddenly changed its course. By mid-1929 interest rates rose from 3.5 to 6%. Even after the collapse of the stock exchange market Fed continued to take deflationary measures, that is why money became more expensive, which caused a sharp drop in prices. (DeGrace). On the eve of the crisis the Fed has taken measures to stabilize the market, and for the period of January – July 1928 the rate was raised from 3.5% to 5%. However, Fed failed to maintain adequate money supply. (Cundiff). If in 1926 the money supply M2 was 43.7, in 1927 it was 44.7 billion dollars. (growth of 2.2%), in 1928 – 46.42 (up by 3.8%), then in 1929 amounted to 46.6 M2 billions. (growth of 0.38 %).

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During the three years of the crisis, by the end of Hoover’s presidency in 1932, GDP fell by 31%, while the unemployment rate rose to 23.6%. One in four working-Americans were left jobless. The biggest danger was cash deficit. In fact, the financial crisis is realized through the mechanism of money supply shock, when the subjects of the market – customers, banks, overestimating risks drastically reduce the money supply, as a consequence, the velocity of circulation was reduced. (Coe). While Fed has consistently pounded in a remote corner of the nation’s banking system, the President Gerhard Hoover was idle. It was believed that Hoover was a supporter of the theory of non-interference in business affairs. But when public dissatisfaction by government’s inability to withstand the crisis has reached the limit, the administration took Smoot-Hawley. Frankly speaking, it would be better for Hoover to continue sitting idly. The law provided an increase on customs duties on 3,218 kinds of commodities. Tariffs were increased on average by 40%. However, the government hoped that protection from foreign competition would revive the domestic market, did not materialize, but led to a new surge in unemployment. Taking Smoot-Hawley, Hoover ignored the obvious fact that international trade was a two-way process. Goods were moving across the border as blood in circulatory system – in both directions. Of course, in response to the actions of the US authorities the US trading partners have also closed their borders for goods from America, setting the high customs duties. (Rothermund).

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Studying the views of economists, bankers, brokers, financial advisers and politicians of the 1920s, we can conclude that the mainstream school of economics wrongly assessed financial events of the end of 1929 without noticing deflationary impact. (White) Summing up the paper, it should be noted that while money was tied to gold reserves, there was restricted money supply to the market (Keynesian explanation). The Fed’s monetary policy (monetarism) should be criticized. The crisis of overproduction was inherent in capitalism. There were investments in production of the exceeded the real market demand (Marx). The crisis of 1929 was a deflationary and had lasted for a long period of time. It changed people’s psychology. The economy has recovered only by 1940, putting an end to irresponsible unregulated capitalism.

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