Special Feature
Panic spread and the market lost 13% in what was the second largest daily loss ever at the time. The following day another loss of 12% was registered. Even though the market managed to recover 12% the following day, the damage had already been done. Confidence was shot to bits and many margined players were flushed out. A downtrend of three years was just getting started. Stock market values dropped an incredible 90% during the ensuing 3 years through to 1932 in what was the worst depression ever . In just four years, the economy saw unemployment rise from 3% to 25%, international trade halved and many people were ruined. Although many say the crash and the depression that followed were not cause-effect, the truth is there is a strong relation. The plunge in the stock market hit confidence in the whole nation and led to the bankruptcy of several banks.
Businesses couldn’t get funds from banks and unemployment rose (ever more parallels with the events of recent times eh?). Consumption was severely hit and a process of economic torpor and contraction was put in motion that was only mitigated when President Hoover started the great American rebuilding program. Even though it is not clear what led to the crash and the subsequent crisis, there are certain factors that were key. First of all, a lesson to learn on valuation never buy overvalued shares with the crowd. High P/E ratios illustrated that a bubble had formed and that sooner or later a crash would occur. Second, the Smoot-Hawley Tariff Act was quite simply ruinous. J.P. Morgan, a key man in the prior crashes, almost begged President Hoover to veto the act as he knew it would be disastrous. He was right. The Act played its role in the crash as many countries retaliated against the crazy import tariffs. In 1933, U.S. international trade was an astonishing 50% lower than where it was at the start of 1929. Third, the fallout from the banks de-leveraging only served to accelerate the problem. A system to diminish the effects deriving from liquidity problems should have been in place, but it wasn’t. Amazingly, it took 25 years until 1954 for the Dow to recover its pre-1929 crisis level.
CHART - THE WALL STREET CRASH OF 1929
10 | www.financial-spread-betting.com | December 2012