What Caused the Wall Street Crash of 1929?

Readers Question: The question is that how did a flawed capitalism of the 1920’s American economy lead to the 1929’s stock market crash?

The 1929 Stock Market crash was a result of various economic imbalances and structural failings. These are some of the most significant economic factors behind the stock market crash of 1929.

Credit Boom

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 was the practise of buying shares on the margin. This meant you only had to pay 10 or 20% of the value of the shares; it meant you were borrowing 80-90% of the value of the shares. This enabled more money to be put into shares, increasing their value. It is said there were many ‘margin millionaire’ investors. They had made huge profits by buying on the margin and watching share prices rise. But, it left investors very exposed when prices fell. These margin millionaires got wiped out when the stock market fall came. It also affected those banks and investors who had lent money to those buying on the margin.

Irrational Exuberance

US Share prices 1920s

Earning per share rose from 20 (1923) to a peak of 100 (1929). A 400% increase.

A lot of the Stock Market crash can be blamed on over exuberance and false expectations. In the years leading up to 1929, the stock market offered the potential for making huge gains in wealth. It was the new gold rush. 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 became divorced from the real potential earnings of the share prices. Prices were not being driven by economic fundamentals but the optimism / exuberance of investors. The average earning per share rose by 400% between 1923 and 1929. Yet, those who questioned the value of shares were often labelled doom-mongers.


This was not the first investment bubble, nor was it the last. Most recently we saw a similar phenomena in the dot com bubble.

In March 1929, the stock market saw its first major reverse, but this mini-panic was overcome leading to a strong rebound in the summer of 1929. By October 1929, shares were grossly overvalued. When some companies posted disappointing results on October 24 (Black Thursday), some investors started to feel this would be a good time to cash in on their profits; share prices began to fall and panic selling caused prices to fall sharply. Financiers, such as JP Morgan tried to restore confidence by buying shares to prop up prices. But, this failed to alter the rapid change in market sentiment.  On October 29(Black Tuesday) share prices fell by $40 billion in a single day. By 1930 the value of shares had fallen by 90%. The bull market had been replaced by a bear market.

 

Mismatch between production and consumption

The 1920s saw great strides in production techniques, especially in industries like automobiles. The production line enable economies of scale and great increases in production. However, demand for buying expensive cars and consumer goods were struggling to keep up. Therefore, towards the end of the 1920s many firms were struggling to sell all their production. This caused some of the disappointing profit results which precipitated falls in share prices.

GDP-economic-growth

Rapid growth in Real GDP during the 1920s, couldn’t be maintained

In 1929, there were already warning signs from the economy with falling car sales, lower steel production and a slowdown in housing construction. However, despite these warning signs, people still kept buying 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 same rate. Therefore, prices fell and farmers incomes dropped. There was occupational and geographical immobilities in this sector, and it was difficult for unemployed farmers to get jobs elsewhere in the economy.

 

Weaknesses in the Banking System

Before the Great Depression, the American banking system was characterised 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

Note: If the question was – What Caused the Great Depression? the answer would be slightly different. This is because some believe the Stock market crash was only partly to blame for the Great Depression (although a significant factor in precipitating it.)

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16 Responses to What Caused the Wall Street Crash of 1929?

  1. Ben October 12, 2008 at 6:54 am #

    You should mention the FED artificially reducing interest rates. That is what lead to the overabundance of credit. Same as the recent stock market crash.

  2. paul bunyan February 23, 2011 at 12:00 am #

    this website needs modification. too many people are placing junk comments that don’t apply to the topic of the wall street crash of 1929.

  3. george bman March 2, 2011 at 1:43 pm #

    well i disagree because of the gold decreased at the end of rainbows due to the invention of the automobile which made there less rainbows and the pollution rose therefore made alot of garbage monsters.

  4. Yolanda Farland March 8, 2011 at 7:39 pm #

    Where would I go to find information on the Stock Market Crash of 1929??

  5. Josh April 8, 2011 at 2:44 am #

    How can one tell the validity of this site? There’s no author, citing, or anything really official.

    • davion new swag March 15, 2012 at 1:26 am #

      thats wat i said

  6. calvin November 29, 2011 at 6:34 pm #

    hello you are trying to claim the great depressionwas caused by the wall street crash but i think things are a little more complicated

    • rob February 4, 2013 at 8:18 pm #

      yes you are right there were a lot more factors like mass production that caused the great depression but the wall street crash played a big part of the great depression.

    • Anonymous May 15, 2013 at 2:31 pm #

      Are you actually retarded or something? The Great depression was a direct result of the Wall Street Crash. That is all there is to it really.

  7. Peter August 19, 2012 at 6:20 pm #

    The instigator of the Wallstreet crash of 1929 was the FED. It was a planned crash. By allowing the people to borrow money to buy stocks and bonds. They even made a new regulation that allowed ordinary people to buy stocks with 90% of the money borrowed. Stock prices already were going up due to the FED money policy that had created a big boom (The roaring 20’s) and everybody wanted to benefit from this so it was no more than natural that ordinary people wanted to get their share of the profit.

    In 1929 the FED announced that the money supply should be contracted because of worries for inflation, and as a consequence the banks from which people had borrowed money for stocks requested the money to be paid back.

    This is of course not the only reason for the crash, the whole economy of the USA was in a boom because of too much money creation (intentionally)

    the 29 crash and ensuing depression has many similarities to the current depression. It is also orcestrated by the central banks, but this is not a surprise because all the minor and mayor crashes after ’29 have been caused by Central Banking overprinting of fiat money. This always creates first booms and then busts.

    Nowadays the situation is much more grave then ever because the Western world and most of the rest of the world also for that matter are more or less drowning in borrowed money, too much to pay back. The EU is on the brink of disaster, so is the USA and so are many of the Bric nations

  8. Brebre December 7, 2012 at 5:55 pm #

    Right?!

  9. Dolan  January 17, 2013 at 1:11 am #

    yes

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