The crash (causes and consequences)

Authors Avatar

The crash (causes and consequences)

In autumn 1932 President-elect Hoover announced ‘We, in America today, are nearer to the final triumph over poverty than ever before in the history of any land.’ He was wrong. America was soon to crash.

IN 1924 a financial crisis which was almost a trial run of the crash took place. Land was bought in Florida with a 10% deposit (called a binder),and then sold for a large profit. An example of such a share scheme occurred between 1924 and 1926. Estate agents described a number of building plots for sale in Florida in glowing terms, even though most of them were swampy and nowhere near the beach. But many Americans were attracted to the prospect of making money through buying land on the warm Florida shores and then selling it for profit. For a while prices rose rapidly and many people did well. But then buyers started to realise that most of the deals were worthless. Prices plunged and many banks, builders and individuals went bankrupt. Finally in 1926 two hurricanes hit Florida and thousands of plots were flooded. The boom was over. By 1929 such examples had shown people the problems associated with trading ‘off the margin’, and interest rates were raised to try and put people off. This did not work.

Some point to 1927 as being a critical year for the US. The sale of new cars fell, fewer houses were built, industrial wages slowed and farmer’s earning fell further. The Federal Reserve Board in 1928 increased interest rates and warned banks not to lend money for stock market speculation, but people took no notice. Long-term weaknesses, and a craze among some Americans for share speculation and get-rich-quick schemes meant the economy was about to go very wrong.

Underlying weaknesses - the long-term causes

Uneven distribution of wealth        By 1929 at least one-third of all income generated by the American economy went to only 5% of the American people. 200 companies controlled 49% of industry. 24,000 families held 34% of the country’s savings. In 1929 43% of families earned less than $1,500 a year and 78% had incomes of less than $3,000, 80% had no savings at all and were close to subsistence level by 1929 according to a Yale ecnomist. Many Americans, therefore, could not afford to but a car, radio or refrigerator. Farmers, blacks and other minorities were left out (see Boom notes). The US economy had been built on the principle of mass production but the market for consumer goods was limited.

Government financial policy        The gov had indulged in income tax cuts in the 1920s and then indulged in a tight monetary squeeze to dry up credit in fear of inflation. It meant that there was so little money in circulation that the economy could not recover. Scant gov regulation of the economy mean that excessive consumer borrowing was not checked.

Poor overseas markets        Foreign nations needed firstly to sell their goods to American firms in order to get the currency they needed to but American goods. But the American government had imposed high tariffs against foreign goods - the Fordney-McCumber tariff of 1922, put in place by Andrew Mellon, Secretary of the Treasury. This made them too expensive. Therefore, these countries, in turn, imposed their own duties on American products. As a result, fewer and fewer American goods were sold abroad.

Declining industries        Some traditional industries were in decline. Coal could not compete with newer forms of energy like oil, electricity and gas which supplied more than half of America’s energy needs. Textiles were also in trouble as new women’s fashions required less material - it took around 19 metres of material to dress a women in 1913 but only 7 metres in 1928. Artificial fibres like rayon were also replacing cotton. Housing construction fell by 25% 1928-9. Small businesses did badly against huge corporations - it is estimated that ¾ of businesses failed in the 1920s. Motor car companies fell from 108 in 1920 to 44 in 1929.

Too many goods and not enough

demand (overproduction)        During the 1920s consumers had been keen to buy all sorts of goods and by the end of the 1920s they had brought all the goods they wanted or could afford. Companies were forced to cut back on production and warehouses began to fill with unsold goods. By 1929, 2 million Americans were out of work. It also meant that as output increased this was not matched by a proportionate increased in consumer buying power. Credit was extended massively to those on low incomes, even to those who had no savings.

Heavy borrowing        By the late 1920s, millions of Americans were in debt. Everyone was so confident in the future that companies, stockbrokers, speculators and private individuals all borrowed heavily from banks and financial institutions. The American banking system was fundamentally weak so that if a large number of investors wanted to withdraw their funds at once, banks would be forced to close. They were not national banks, but local state banks with insufficient funds to cover unusual demands. They had lent too freely and also used depositor’s money to make a quick profit for themselves on the stock market.

The underlying weakness

of the banking system        There were 12 regulatory reserve banks headed by the Federal Reserve Board. The system allowed banks to regulate themselves and represented the banks and not the nation. State banks did not join this system. Most people, especially in rural areas invested in state banks of which there were 30,000 in the USA. There was no deposit insurance and the Federal Reserve Board tended to keep interest rates low in order to keep the market buoyant. There was no effective control over the stock market, either. The Federal Reserve actually bought gov securities from banks which gave them more money to lend and reduced the rediscount rate in 1927, allowing more borrowing. When this was raised in 1928 to 5% it was too late. The Federal Reserve was anxious to protect overseas trade and was after all run by bankers. The Board offered little real leadership and would have found it hard to slow the market down due to the general mood and gov policy.

The cycle of  international debt        Europe could not afford to pay back the loans and US tariffs made it worse as they could not export to the USA. Therefore, they could not earn money to pay back loans. US loans to Europe meant that it was in effect paying their own debt back. Americans further massively over-invested in Germany in order to build up their industry so that these debts could be paid back. They were spurred on by commission hungry brokers. It meant that the international situation was very fragile

The Wall Street share boom        Americans during the 1920s loved playing the markets. It was in 1933 that Monopoly was granted a patent, though it had been a game played for the pervious 20 years to so. Prices rose but were based on demand rather than on the real value of companies. Throughout the 1920s, as company profits increased, buying stocks and shares was seen as risk-free. This was the speculation game - speculators invested in private companies and as soon as the share price rose, they sold at a profit. More and more ordinary Americans bought shares, sometimes investing their life savings. The Director of General Motors in 1928 wrote: ‘Suppose a man begins a regular savings of $8 a month. If he invests in common stocks, he will, after 20 years, have at least $80,000.’ By the summer of 1929 stock prices had nearly quadrupled compared to 1925. Transactions ran to 5 million a day. The share boom was at its peak from 1927 to 1929. Sometimes share prices fell, but buyers hoping for a bargain would buy up these shares and confidence in the market would return. But this system only worked as long as everybody was confidence that share prices would keep on rising.  Business was a religion. The book by Bruce Barton, The Man Nobody Knows told the life of Jesus in business terms. Corporate leaders like John Rashob were trusted when they wrote articles such as ‘Everybody ought to be rich’. It was estimated that $15 invested per week over 20 years could bring in $4000 per week from investments. Why did so many people buy them (actually the numbers were not as high as many assume, only 1 million people were really serious investors)? Mainly because it was seen as the American Dream to go from rags to riches, and for a brief period it seemed buying shares was the way to do it.

Join now!

Buying on the margin        Owning shares was made even easier because they could be bought on credit. The stockbroker would accept around a 10% deposit called a ‘margin’. With luck, the shares could be sold before the rest had to be paid. A big profit could be made for a very small investment. Brokers took this risk because they were so confident that the prices of shares would keep on rising.

The share bubble of speculation        While confidence remained, the share boom continued. By 1929, people from all sections of society all seemed to be playing the market. Billions of ...

This is a preview of the whole essay