The speculative bubble
The Florida land boom of the 1920s established the mood "and the conviction that God intended the American middle classes to be rich," a sentiment so strong that it survived the ensuing crash of property prices. [6] In the early 1920s, yields of common stocks were favorable and prices low. In the final six months of 1924, prices began to rise and continued through 1925, from 106 in May 1924 stock prices rose to 181 by December 1925. [7] After a couple of short downturns during 1926, prices began to increase in earnest throughout 1927, the year in which conventional wisdom saw the seeds of what became the Great Crash sown. Following Britain's return to the Gold Standard, and subsequent foreign exchange crises, there followed an exodus of gold from Europe to the United States.
In the spring of 1927, Montagu Norman and other governors of European Banks asked the Federal Reserve to ease their monetary policy and they agreed, reducing the rediscount rate from 4 to 3.5%, a move that Lional Robbins described as resulting “in one of the most costly errors committed by it or any other banking system in the last 75 years”. The funds released by the Fed became available to invest in the stock market and “from that date, according to all the evidence, the situation got completely out of control.” [8] Galbraith disagreed with this simplistic analysis by arguing that the availability of money in the past was no sure recipe for a bubble in common stocks and that prices could still be regarded as a true valuation of the stock at the end of 1927. It is early in 1928 that the “escape into make believe” started in earnest, when the market began to rise by large vaulting leaps rather than steady increments. Prominent investors, such as Harrison Williams, the proponent of both the Shenandoah & Blue Ridge Trusts, were described by Professor Dice as “having vision for the future and boundless hope and optimism” and not “hampered by the heavy armour of tradition”. [9]
On 12 March, the volume of trading had reached 3,875,910 shares, an all-time high. By 20 June, 5,052,790 shares were traded in a falling market that many prematurely thought signalled the end of the bull market. [10] Prices rose once more and after the election of Hoover, with a “victory boom” resulting in an all-time record trading of 6,641,250 shares in a rising market (16 November). Overall, the market rose during the year from 245 to 331 which was accompanied by a phenomenal increase in trading on margin, [11] which relieved the buyer from putting up the full purchase price of the stock by using the securities as collateral for a loan. The buyer obtained full benefit of ownership in rising stock valuation, but the loan amount remained the same. People swarmed to buy stock on margin. In the early 1920s, brokers' loans used to finance purchases on margin averaged 1–1.5 billion but by November 1928 had reached six billion. By the end of 1928, the interest on such loans was yielding 12% to lenders which led to a flood of gold converging on Wall St. from all over the world to fuel the purchase of stocks on margin. [12]
The influence of the Wall Street crash on the Great Depression
Contrary to what had been Wall Street's perceived tendency in playing down its influence, Galbraith asserted the important contribution of the 1929 crash on the Great Depression which followed: [15] causing a contraction of demand for goods, destroying for a time the normal means of investment and lending, arresting economic growth and causing financial hardship which alienated many from the economic system. [2] Galbraith further argues that the Great Depression was caused by a mixture of five main weaknesses:
First, an imbalance in the income distribution. Galbraith asserts that "the 5 per cent of the population with the highest incomes in that year [1929] received approximately one third of all personal income." Personal income in the form of rents, dividends, and interest of the well-to-do was approximately twice as much as in the period following the Second World War, leaving the economy dependent on a high level of investment and luxury consumer spending, and vulnerable to the stock market crash. [16]
Second, problems in the structure of corporations. Most specifically, he cites newly formed investment entities of the era (such as holding companies and investment trusts) as contributing to a deflationary spiral, due in no small part to their high reliance on leverage. Dividends paid the interest on the bonds in the holding companies, and when these were interrupted, the structure collapsed. “It would be hard to imagine a corporate system better designed to continue and accentuate a deflationary cycle." Also, "The fact was that American enterprise in the twenties had opened its hospitable arms to an exceptional number of promoters, grafters, swindlers, impostors, and frauds. This, in the long history of such activities, was a kind of flood tide of corporate larceny." [16]
Third, the bad banking structure. The weakness was manifest in the large number of units working independently. As one failed, pressure was applied to another, leading to a domino effect accelerated by increasing unemployment and lower incomes. [17]
Fourth, foreign trade imbalances. During World War I, the US became a creditor nation, exporting more than it imported. High tariffs on imports contributed to this imbalance. Subsequent defaults by foreign governments led to a decline in exports, which was especially hard on farmers.
And finally, "the poor state of economic intelligence." Galbraith says that the "economists and those who offered economic counsel in the late twenties and early thirties were almost uniquely perverse" and that "the burden of reputable economic advice was invariably on the side of measures that would make things worse." [18]
In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0%. Inflation reduces the value of currency over time, but deflation increases it. This allows more goods and services to be bought than before with the same amount of currency. Deflation is distinct from disinflation, a slowdown in the inflation rate; i.e., when inflation declines to a lower rate but is still positive.
A stock market, equity market, or share market is the aggregation of buyers and sellers of stocks, which represent ownership claims on businesses; these may include securities listed on a public stock exchange as well as stock that is only traded privately, such as shares of private companies that are sold to investors through equity crowdfunding platforms. Investments are usually made with an investment strategy in mind.
A stock market crash is a sudden dramatic decline of stock prices across a major cross-section of a stock market, resulting in a significant loss of paper wealth. Crashes are driven by panic selling and underlying economic factors. They often follow speculation and economic bubbles.
A stock market bubble is a type of economic bubble taking place in stock markets when market participants drive stock prices above their value in relation to some system of stock valuation.
In finance, speculation is the purchase of an asset with the hope that it will become more valuable shortly. It can also refer to short sales in which the speculator hopes for a decline in value.
Investment is traditionally defined as the "commitment of resources to achieve later benefits". If an investment involves money, then it can be defined as a "commitment of money to receive more money later". From a broader viewpoint, an investment can be defined as "to tailor the pattern of expenditure and receipt of resources to optimise the desirable patterns of these flows". When expenditures and receipts are defined in terms of money, then the net monetary receipt in a time period is termed cash flow, while money received in a series of several time periods is termed cash flow stream.
In finance, being short in an asset means investing in such a way that the investor will profit if the value of the asset falls. This is the opposite of a more conventional "long" position, where the investor will profit if the value of the asset rises.
An economic bubble is a period when current asset prices greatly exceed their intrinsic valuation, being the valuation that the underlying long-term fundamentals justify. Bubbles can be caused by overly optimistic projections about the scale and sustainability of growth, and/or by the belief that intrinsic valuation is no longer relevant when making an investment. They have appeared in most asset classes, including equities, commodities, real estate, and even esoteric assets. Bubbles usually form as a result of either excess liquidity in markets, and/or changed investor psychology. Large multi-asset bubbles, are attributed to central banking liquidity.
The Wall Street Crash of 1929, also known as the Great Crash or the Crash of '29, was a major American stock market crash that occurred in the autumn of 1929. It started in September, when share prices on the New York Stock Exchange (NYSE) collapsed, and ended in mid-November. The pivotal role of the 1920s' high-flying bull market and the subsequent catastrophic collapse of the NYSE in late 1929 is often highlighted in explanations of the causes of the worldwide Great Depression.
Black Monday was the global, severe and largely unexpected stock market crash on Monday, October 19, 1987. Worldwide losses were estimated at US$1.71 trillion. The severity of the crash sparked fears of extended economic instability or even a reprise of the Great Depression.
The causes of the Great Depression in the early 20th century in the United States have been extensively discussed by economists and remain a matter of active debate. They are part of the larger debate about economic crises and recessions. The specific economic events that took place during the Great Depression are well established.
A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these panics. Other situations that are often called financial crises include stock market crashes and the bursting of other financial bubbles, currency crises, and sovereign defaults. Financial crises directly result in a loss of paper wealth but do not necessarily result in significant changes in the real economy.
The Kennedy Slide of 1962, also known as the Flash Crash of 1962, is the term given to the stock market decline from December 1961 to June 1962 during the Presidential term of John F. Kennedy. After the market experienced decades of growth since the Wall Street Crash of 1929, the stock market peaked during the end of 1961 and plummeted during the first half of 1962. During this period, the S&P 500 declined 22.5%, and the stock market did not experience a stable recovery until after the end of the Cuban Missile Crisis. The Dow Jones Industrial Average fell 5.7%, down 34.95, the second-largest point decline then on record.
Hyman Philip Minsky was an American economist, a professor of economics at Washington University in St. Louis, and a distinguished scholar at the Levy Economics Institute of Bard College. His research attempted to provide an understanding and explanation of the characteristics of financial crises, which he attributed to swings in a potentially fragile financial system. Minsky is sometimes described as a post-Keynesian economist because, in the Keynesian tradition, he supported some government intervention in financial markets, opposed some of the financial deregulation of the 1980s, stressed the importance of the Federal Reserve as a lender of last resort and argued against the over-accumulation of private debt in the financial markets.
Debt deflation is a theory that recessions and depressions are due to the overall level of debt rising in real value because of deflation, causing people to default on their consumer loans and mortgages. Bank assets fall because of the defaults and because the value of their collateral falls, leading to a surge in bank insolvencies, a reduction in lending and by extension, a reduction in spending.
The Great Depression (1929–1939) was a severe global economic downturn that affected many countries across the world. It became evident after a sharp decline in stock prices in the United States, leading to a period of economic depression. The economic contagion began around September 1929 and led to the Wall Street stock market crash of 24 October. This crisis marked the start of a prolonged period of economic hardship characterized by high unemployment rates and widespread business failures.
The initial economic collapse which resulted in the Great Depression can be divided into two parts: 1929 to mid-1931, and then mid-1931 to 1933. The initial decline lasted from mid-1929 to mid-1931. During this time, most people believed that the decline was merely a bad recession, worse than the recessions that occurred in 1923 and 1927, but not as bad as the Depression of 1920-21. Economic forecasters throughout 1930 optimistically predicted an economic rebound come 1931, and felt vindicated by a stock market rally in the spring of 1930.
A. Gary Shilling is an American financial analyst and commentator who appears regularly in publications such as Forbes, The New York Times, and The Wall Street Journal. He is president of A. Gary Shilling & Co., Inc., editor of A. Gary Shilling's Insight, and a member of the Nihon Keizai Shimbun Board of Economists. He is featured frequently on business shows on radio and television, and as a recognised orator, addresses conventions of global business groups like the Young Presidents' Organization. More than two years before the housing bubble burst, Shilling warned that subprime loans were probably "the greatest financial problem" for the future U.S. economy, and in January 2006, prior to the 2008 recession, he wrote an article entitled: “The Housing Bubble Will Probably Burst”. In 2007 he correctly prophesied that housing would "sink the economy".
The real bills doctrine says that as long as bankers lend to businessmen only against the security (collateral) of short-term 30-, 60-, or 90-day commercial paper representing claims to real goods in the process of production, the loans will be just sufficient to finance the production of goods. The doctrine seeks to have real output determine its own means of purchase without affecting prices. Under the real bills doctrine, there is only one policy role for the central bank: lending commercial banks the necessary reserves against real customer bills, which the banks offer as collateral. The term "real bills doctrine" was coined by Lloyd Mints in his 1945 book, A History of Banking Theory. The doctrine was previously known as "the commercial loan theory of banking".
