25.1 The stock market crash of 1929  (Page 6/16)

After World War I, both America’s allies and the defeated nations of Germany and Austria contended with disastrous economies. The Allies owed large amounts of money to U.S. banks, which had advanced them money during the war effort. Unable to repay these debts, the Allies looked to reparations from Germany and Austria to help. The economies of those countries, however, were struggling badly, and they could not pay their reparations, despite the loans that the U.S. provided to assist with their payments. The U.S. government refused to forgive these loans, and American banks were in the position of extending additional private loans to foreign governments, who used them to repay their debts to the U.S. government, essentially shifting their obligations to private banks. When other countries began to default on this second wave of private bank loans, still more strain was placed on U.S. banks, which soon sought to liquidate these loans at the first sign of a stock market crisis.

Poor income distribution among Americans compounded the problem. A strong stock market relies on today’s buyers becoming tomorrow’s sellers, and therefore it must always have an influx of new buyers. In the 1920s, this was not the case. Eighty percent of American families had virtually no savings, and only one-half to 1 percent of Americans controlled over a third of the wealth. This scenario meant that there were no new buyers coming into the marketplace, and nowhere for sellers to unload their stock as the speculation came to a close. In addition, the vast majority of Americans with limited savings lost their accounts as local banks closed, and likewise lost their jobs as investment in business and industry came to a screeching halt.

Finally, one of the most important factors in the crash was the contagion effect of panic. For much of the 1920s, the public felt confident that prosperity would continue forever, and therefore, in a self-fulfilling cycle, the market continued to grow. But once the panic began, it spread quickly and with the same cyclical results; people were worried that the market was going down, they sold their stock, and the market continued to drop. This was partly due to Americans’ inability to weather market volatility, given the limited cash surpluses they had on hand, as well as their psychological concern that economic recovery might never happen.

In the aftermath of the crash

After the crash, Hoover announced that the economy was “fundamentally sound.” On the last day of trading in 1929, the New York Stock Exchange held its annual wild and lavish party, complete with confetti, musicians, and illegal alcohol. The U.S. Department of Labor predicted that 1930 would be “a splendid employment year.” These sentiments were not as baseless as it may seem in hindsight. Historically, markets cycled up and down, and periods of growth were often followed by downturns that corrected themselves. But this time, there was no market correction; rather, the abrupt shock of the crash was followed by an even more devastating depression. Investors, along with the general public, withdrew their money from banks by the thousands, fearing the banks would go under. The more people pulled out their money in bank runs , the closer the banks came to insolvency ( [link] ).