Significant Economic Factors Behind the Stock Market Crash of 1929:
Credit Boom – In the 1920s, there was a rapid growth in bank credit and loans. Encouraged by the strength of the economy, people felt the stock market was a one way bet. Some consumers borrowed to buy shares. Firms took out more loans for expansion. Because people became highly indebted, it meant they became more susceptible to a change in confidence. When that change of confidence came in 1929, those who had borrowed were particularly exposed and joined the rush to sell shares and try and redeem their debts.
Buying on the Margin – Related to buying on credit, practice of buying shares on the margin. Meant you only had to pay 10 or 20% of the value of the shares; borrowing 80-90%. Enabled more money to be put into shares, increasing their value. Many made huge profits by buying on the margin and watching share prices rise; however, investors were left utterly exposed when prices fell. Margin millionaires got wiped out when the stock market fall came, and banks who had lent money to those buying on the margin suffered as well.
Irrational Exuberance – False expectations. In the years leading up to 1929, the stock market offered the potential for making huge gains in wealth. People bought shares with the expectations of making more money. As share prices rose, people started to borrow money to invest in the stock market. The market got caught up in a speculative bubble; shares kept rising and people felt they would continue to do so. The problem was that stock prices were not being driven by true economic fundamentals but the optimism / exuberance of investors. By October 1929, shares were grossly overvalued. When companies posted disappointing results on October 24 (Black Thursday), many investors began to feel that it was a good time to cash in on their profits; share prices began to fall and panic selling caused prices to plummet dramatically. By 1930 the value of shares had fallen by 90%.
Mismatch between production and consumption – The 1920s saw great strides in production techniques, especially in industries such as that of automobiles. The production line enabled increases in production on an unprecedented scale; however, demand for consumer goods was struggling to keep up. Toward the end of the 1920s, many firms found themselves with an overwhelming surplus of goods, leading to a sharp decline in profits and falls in share prices. By 1929, there were already warning signs of a battered economy with falling car sales, lower steel production, and slow housing construction. In spite of this, however, people continued to buy shares.
Agricultural Recession – Even before 1929, the American agricultural sector was struggling to maintain profitability. Many small farmers were driven out of business because they could not compete in the new economic climate. Better technology was increasing supply, but demand for food was not increasing at the same rate; therefore, prices fell and farmers’ incomes dropped. It was virtually impossible for unemployed farmers to get jobs elsewhere in the economy.
Weaknesses in the Banking System – Before the Great Depression, the American banking system was characterized by having many small to medium-sized firms. America had over 30,000 banks. The effect of this was that they were prone to going bankrupt if there was a run on deposits. In particular, many banks in rural areas went bankrupt due to the agricultural recession. This had a negative impact on the rest of the financial industry. Between 1923 and 1930 5,000 banks collapsed.
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