Stock Market Crash

THE 1929 STOCK MARKET CRASH:
Lessons Learnt


Abstract
The complexity and magnitude of the economic catastrophe during the period of stock market crash made governments worldwide reassess their current economic framework. This paper will focus on how the 1929 stock market crash taught the need for international cooperation to prevent policies such as protectionism, which could lead to trade wars and competitive devaluation by countries. In conjunction with the need for appropriate macroeconomic policies influenced by new theories and national experiences of recovery that took place throughout this time. Thus, nations need to ensure a financial market infrastructure that inspires confidence through transparency. In addition, macroeconomic policy, especially monetary policy, now pays more attention to financial stability issues, with a global perspective.
Keywords: Stock, Trade, Macroeconomics, International


I. INTRODUCTION
The conceptual frameworks of the global and national economies are forever changing and improving as they are influenced by national as well as global experiences, continual integration, and application of new and existing economic theories. Some of the most notable and significant global economic changes stems from the 1929 stock market crash.
Over the four years beginning in the summer of 1929, financial markets, labour markets and goods markets all virtually ceased to function. The defining characteristic of this period is the collapse of virtually every aspect of the economy. Throughout this term, the government policymaking apparatus seemed helpless. The complexity and magnitude of the economic catastrophe during this period made governments worldwide reassess their current economic framework. For this reason economic institutions are very different today than they were in 1929. Globalized markets now operate within politically defined rules and governance institutions. As well as the creation of global regulations, institutional framework, and economic governance sanctioned.
This paper examines the lesson learnt from the 1929 stock market crash. Procuring the view that the 1929 stock market crash provided numerous lessons to be learnt, identifying and recognizing two overall lessons were therefore fundamentally important in changing the global economy to its current framework. In addition, this paper also discusses the consequences of stock market crash in the context of Italy because Italy experienced a lower degree of industrial development during that period.
II. THE 1929 STOCK MARKET
This section will elucidate, illustrate, and define the causes, impacts, solutions and events that transpired throughout the 1929 stock market crash and great depression
2.1 What transpired?
In October 1929 shares in Wall Street fell sharply following a speculative boom during the period known as the Roaring Twenties. Within two days, the Dow Jones industrial average fell by 25% ending on Black Tuesday, 29th of October. The volume of stocks traded set a record that was not broken for 40 years. When it finally reached its record low in July 1932, the Dow Jones had fallen 89%, and it did not recover to 1929 levels until 1954 (Galbraith, 1997; Weidenbaum & White, 1990).
In the US, the recession began in September 1929 and continued officially until March 1933. By the end of the 3.5‐year long down‐ turn, industrial production shrank by half. Consumer prices dropped by over a quarter and unemployment surged from 3.2 % to nearly 25 %. This period is visually aided below in figure 1, illustrating the stock market and its level in conjunction with the year (Galbraith, 1997; Weidenbaum & White, 1990).
Figure 1: The 1929 Stock Market

Source: The Great Stock Market Crash of 1929, 2009
2.2 What was the cause?
Debates continue over the causes of the Wall Street crash, there are numerous contributing arguments and factors that are defined throughout this period. Although the prevailing mainstream economic belief today is that monetary policy errors transformed what may have been a normal recession in the early 1930s into the Great Depression. It is believed that the Federal Reserve was the foundation of the Great Crash and the subsequent economic downturn by tapering policy in order to deflate the asset bubble fermenting in the equity markets. The Federal tightened monetary policy from the march of 1928 until the Great Crash despite moderate economic performance, many Federal officials at the time believed that speculative investment was fruitless and required hindering. This was part of a set of guidelines, that if banks limited their lending to sound businesses, the appropriate amount of money would automatically regenerate (Galbraith, 1997; Hall & Ferguson, 1998; Weidenbaum & White 1990).
Therefore, the Federal was to constrain any manner of lending, especially loans for buying stocks or bonds. This policy resulted in a pro-cyclical monetary strategy, since business loans had a propensity to enlarge and contract with the economic cycle. The unconstructive monetary policy and the aspiration to discontinue speculative investments are aspects that contribute to the Great Depression. At that time, professional economists such as Irving Fisher provided no consensus view, but a number of them also argued that the stock market was in line with fundamentals (Galbraith, 1997; Hall & Ferguson, 1998; Weidenbaum & White, 1990).
2.3 What was the impact?
The Wall Street crash correspond to an astute decline in US economic output, which eventually spread around the world. The US economy shriveled by a third illustrated by Figure 2 it demonstrate the dramatic drop in GDP over this period. While unemployment constantly rose, with many more workers on short hours, Figure 3 below visually depicts the unemployment rate rising, as US economic output withered. In conjunction, the US banking system had seized up completely, and the first act of the new Roosevelt administration when it came to power was to close all banks for two weeks while Federal inspectors examined their books.
Bankruptcies were increasingly numbered, while bank loans were not being repaid, furthermore there was no federally guaranteed depositors insurance to inspire depositor confidence, and in 1929 alone, there had been 659 bank failures. With no unemployment benefits or government help, the sharp fall in workers income had a big effect on consumption and led to a negative spiral of more factory closures, as the vicious cycle continued. Most observers believe that economic policymakers made the economic downturn worse by adopting tight monetary policy and balanced budgets as the crisis exacerbated. International trade also shrank as the US went off the gold standard and erected high tariff barriers to prevent foreign imports (Galbraith, 1997; Hall & Ferguson, 1998; Weidenbaum & Robbins, 2009).








Figure 2: GDP of USA in the Period of 1920-1940

Source: Carter, 2006
Figure 3: The Unemployment Rate from 1929 to 1940

2.4 How was the situation and responded to and resolved?
The Great Depression lingered on despite the variety of New Deal measures that attempted to alleviate the suffering of individuals by providing government jobs, welfare relief, or mortgage protection. On top of the federal governments actions, such as tightening of monetary policy, tariffs, and increasing discount rates. Initially the authorities tried to rebuild confidence in markets by making reassuring speeches, but only a shakeout of workers from industry would ultimately restore prosperity (Hall & Ferguson, 1998).
Private charity was relied on to help the victims of the slowdown. In 1932, the US government intervened to provide unemployment relief, to stabilize markets by restricting production, to encourage unions, and to create a government system of old age pensions and unemployment insurance known as social security. However, the administration had less success in reviving economic growth and business confidence remained weak (Hall & Ferguson, 1998; Weidenbaum & Robbins, 2009).
It was only the onset of World War II, when the US government finally embraced Keynesian-style deficit spending on a large scale that the economy recovered. US economic output doubled during the war, and unemployment vanished as women and African Americans were drawn into the workforce to substitute the millions drafted into the military. At its peak, the US government was borrowing half the money needed to finance the war, while half raised by taxes (Galbraith, 1997, Hall & Ferguson, 1998; Weidenbaum & Robbins, 2009).
The 1929 stock market crash and the great depression following cannot be pinpointed from one action alone, although blame namely rests with a failure of monetary policy and political decisions such as implementing trade tariffs. Furthermore, these failures
III. LESSONS LEARNT
This section will explicate the need found for appropriate macroeconomics policies, influenced by new theories and national experiences of recuperation throughout this period. In addition, it will elaborate on the need for international cooperation, to ensure prevention of trade wars and competitive devaluations.
3.1 The Need for Appropriate Macroeconomic Policies
3.2.1 New Theories of Economic Governance
One of the most significant lessons learnt throughout this period was the need for transformation in current economic theories and economic governance. The notion that the stock market crash and the Great Depression would turn out to be “good medicine” for the economy, and the proponents of simulative policies were shortsighted enemies of the public welfare was the belief by many countries throughout this period. Hence, fiscal policy also failed to respond immediately to the Great Depression, prior to the 1930s, since active fiscal policies was nonexistent (Hall & Ferguson, 1998; Weidenbaum & Robbins, 2009).
Economist such as Keynes believed governments should use its immense financial powers such as taxing and spending, as a sort of counterbalance to stabilise the economy. Thus, depressions ought to be attacked with increased government spending at the bottom of the income pyramid. This position is the opposite of the trickle down affect. Keynesian economists call this counter‐cyclical demand management, believing that the government's massive financial impact can be used as a counterweight to current market forces. (Cechetti, 1997; Eichengreen, 1995; Fair, 2000)
Keynes feared that "the slump" that he saw in 1930 possibly will pass over into a depression, along with a drooping price level, that has the capacity to last for years with incalculable damage to the material wealth and to the social stability of every country alike. Calling for a resolution via coordinated monetary expansion by the major industrial economies would repair confidence in the international long-term bond market and raise prices and profits, so that in due course the commerce of the world’s economy would be in motion once more (Cechetti, 1997; Eichengreen, 1995; Fair, 2000).
Keynes believed that people did not have enough income to buy everything the economy produced, so prices fell and business went bankrupt. He argued that governments could halt the vicious cycle by increasing spending on its own or by cutting taxes. Either way incomes would rise or people would spend more. If the government had to run a deficit, so be it, because the alternative would be much worse, believing it was common sense to put idle resources to work. Furthermore, savings otherwise not invested and workers left unemployed could generate beneficial public assets if the government took the initiative (Cechetti, 1997; Eichengreen, 1995; Fair, 2000).
When Keynesianism ideology was applied to construct a fiscal revolution to pull the economy out of depression, this challenged the idea of constantly balancing the budget, via boosting effective demand by stimulating consumption. Keynes rightly invoked fresh economic approaches rather than taking refuge in motionless policy. The pronouncement “in the long run we are al dead” was an scolding reproach against the irresponsibility of doing naught if economist rely on the self-correcting power of market forces (Cechetti, 1997; Eichengreen, 1995; Fair, 2000).
Although there were exceptions of the economic collapsed, this period substantiated need for alternative policies of economic governance at an international and state level. Allowing them to gain from alternative thoughts and new models that arose out of this period and hence, the exploration of a country’s economic policies in this time, enabled states to learn and will encourage appropriate monetary policy in the future situations.
3.2.2 National Experiences of Recovery
Sweden provides example of how a small country could close its door to the transmission of the depression by following a wise economic and financial policy. To some extent, this was due to good advice by Swedish economists to a government that was prepared to listen to them. However, it was also because Sweden had no deep homemade catastrophe to cope with. The Swedish central bank followed a cautious and steady policy aimed at stabilizing the price level. The central bank did not indulge in deflationary measures nor did it give in to an inflationary course. Its monetary policy was close to the ideals of the monetarists (Fregert, 2000; Kindleberger, 1986).
The performance of the Swedish central bank before September 1931 was quite similar to that of the Bank of England. It tried to stick to the gold standard, although it was forced to withdraw from it, as was the Bank of England, due to Swedish banks had also been in the business of accepting short‐term deposits and lending money abroad at long term rates. Going off the gold standard was not an automatic reaction to the British decision. The Swedish central bank tried to stick to the gold standard for two more weeks, but the outflow of reserves forced it to follow the British precedent. The bank’s period of wisdom began only after that decision. Money supply tied into a consumer price index that the bank compiled and published every week. With regard to the exchange rate, the bank sought to follow a course of keeping it down so that Sweden would gain a competitive edge over other countries. However, the bank did not have enough reserves to sell Swedish currency abroad, consequently driving the rate down. At this stage, a financial disaster that came as a great surprise to the bank finally confirmed to be a positive in disguise (Fregert, 2000; Kindleberger, 1986).
The disaster was the abrupt collapse of the financial empire of Ivar Kreuger. Although, it was how the Swedish central bank managed the collapse is the lesson, instantaneously rescuing the affected banks and restoring confidence in the Swedish system. Although, doing nothing to inflate the exchange rate, as it had sought to drive it down. Thus, Sweden had the best of both worlds, admired for its prompt rescue operation it could not be liable for driving down the exchange rate (Fregert, 2000; Partnoy, F 2009).
Sweden adapted and coped with this period, using new thoughts and economic frameworks such as Keynes. The discussion and analysis on the trials and tribulations of governments and central banks globally throughout the stock market crash, provides us with a guide and framework on how to cope with a crash in the future by using appropriate macroeconomic policies.
Figure 4: Summary of the Swedish Markets Response to The Recession

Source: Fregert, 2000; Kindleberger, 1986
3.2 The Need for International Cooperation
3.2.1 Protectionism and International Trade Throughout the Crisis
The stock market crash of 1929 and the great depression following was a worldwide phenomenon, affecting the majority of the industrialized countries. The pervasiveness of the economic collapse saw countries looking after themselves first. Hence, protectionism and devaluation had been discussed as alternative measures of crisis management. Keynes and other economists thought that there was no need to opt for protectionism after one had already opted for the other alternative. But political pressure had gathered such momentum in most countries that protectionism could not be stopped any longer. Many industries, which had priced themselves out of the market internationally and now, wanted to be sure of their control of the home market. Export industries were in favour of free trade but the abandonment of the principle of free trade and the recourse to protectionism was a global trend, which many could not resist for any length of time. America had set a precedent, which was followed by one nation after another. When US government devalued the dollar, the impact of the devaluation of the pound was reduced in this way hence the protectionists succeeded. Those who had advocated the measure could announce they had been right with the bonus of gaining new converts (Pomfret, 1988; Banziger, 2008).
As global trade came to a halt, and a series of sovereign debt defaults lead to the collapse of the international financial system. It is tempting to imagine that the period was a time of international policy paralysis with policymakers purely ignorant of the risks they were running. There were plenty of attempts to tackle problems on an international level, this culminated in a World Economic Conference in 1933 that brought 66 nations together. Surveying the conference’s wreckage, Keynes’s conclusion was a sobering one, 66 countries could never be expected to agree. Only a ‘single power or a like‐minded group of powers’ could prevail. Furthermore, only then if they were equipped with a new understanding of the world’s systemic problems, and a new toolbox with which to tackle them and the forces that were to lead to war. These forces were already building, the projects and politics of militarism and imperialism, of racial and cultural rivalries, of monopolies, restrictions, and exclusion, which were to play the serpent to this paradise appeared to exercise almost no influence at all on the ordinary course of social and economic life. Rapid social, technological and economic development had brought about a new paradigm of ‘industrial war’. Countries were enmeshed in a system of diplomacy that was intricate in its operation, but in which levels of mistrust had steadily grown (Banziger, 2008; Steven, 2009).
3.2.2 Global Organizations
This period bought the need to form central multilateral institutions concerned with the overall functioning of the global economy and the global monetary and financial system with goal such as diplomacy. These organsisations need to cover three goals as shown in figure 5.







Figure 5: Three Goals for Creating and Running Multilateral Institutions

Source: Steven, 2009
Shared awareness, which will cover the joint analysis of future challenges, one that is sufficiently broad to bring together economic, security and scarcity issues, and that has buy‐in not just from governments, but from non‐state actors too. Shared platforms allowing coalitions of countries that begin to harmonize their domestic policies and commitments in example whether on banking reform, or climate change, or investment in agriculture, and use this as the basis for lobbying for more fundamental international reforms.
A shared operating system, which works on new global frameworks and institutions, with a mandate to deliver security and sustainable growth over the long‐term to promote the cooperation of central banks and governments to provide a meeting place for international organizations and governments to exchange information, discuss common problems, agree on shared aims, set common standards, and possibly even provide mutual support. This objective is to be viewed against the background of the 1920s, when there had been episodic, typically bilateral cooperation among central banks. Indeed episodes of cooperation could of prevented and stopped tariffs and quotas etc. and allowed a more harmonized financial world supporting each other (Banziger, 2008; Steven, 2009).
3.2.3 Major Policy Differences from the Past
Governance is not simply a matter of designing an optimal system and then putting it in place through whatever mechanisms are available including coercion if necessary. Rather, it should be thought of as a communicative and consultative process through which disputes are resolved, consensus is built and performance is continually reviewed. No less critical to its success than its policy instruments is the forum that a governance arrangement must provide for the expression of claims, review, and discussion of continuing reform. Above all, good governance is good process.
To develop the required new arrangements for the effective governance of the global economy one must therefore begin with an effective and credible process ideally involving civil society and business provided there is appropriate limitations, as well as governments and existing international organizations (Banziger, 2008; Steven, 2009). The 1929 crisis illustrated the need for international structure and capacity as it allowed authorities to understand that a protectionism attitude will endanger global trade and the capacity for the economy to recover in a depression. Throughout the crisis it was proven protectionism accelerated the cyclical downturn and the capital destruction process, it has now been learnt that transparency and nationalization was needed.
IV. CASE STUDY: ITALY
The economic recession experienced by many countries in the late 1920s and early 1930s also affected Italy. Despite the lower degree of industrial development in the Italian economy, the dynamics of the depression in Italy were not very different from those of more industrialized countries like England, France, and the United States. Although the fall in aggregate production was smaller as shown below in figure 6, the contraction in industrial production was as rigorous as in more industrialized countries. Furthermore, the key features of the Italian depression can be summarized as a persistent decline in international trade. A large fall in hours worked and production in the tradable sector, but negligible changes in the non-tradable sector, with a hefty fall in investment, and stability of the real wages which is depicted in figure 7 (Cole & Ohanian, 2001; Crucini & Kahn, 1996; Mattesini & Quintieri, 1997).
Figure 6: Industrial Production Per Capita

Source: Mattesini & Quintieri, 1997





Figure 7: Average Industrial Wages in Liras per Hour

Source: Mattesini & Quintieri, 1997
Finding the causes of the fall in foreign trade is not difficult. Many countries, including Italy, implemented protectionist policies starting in the late 1920s. These policies took several forms, such as import tariffs, currency control, and quota restrictions. The consequence was a dramatic fall in international trade. Increasing barriers to trade was the main cause for Italy’s economic downfall, restrictions and protectionist policies weren’t in place and stronger international cooperation Italy would of felt the depression alot less. Looking back, the need for international cooperation is quite significant as increasing barriers to trade, together with real wage rigidities, can explain a large proportion of the economic downturn experienced by Italy at the beginning of the 1930s (Cole & Ohanian, 2001; Crucini & Kahn, 1996; Mattesini & Quintieri, 1997).
The fall in international trade is probably the most striking aspect of the period surrounding the Great Depression. Foreign trade was relatively stable until the end of the 1920s, when it started a rapid and persistent decline. Hence protectionist policies implemented at the end of the 1920s and during the 1930s were an important driving force of the Great Depression in Italy. The political forces motivating the adoption of these policies in Italy and in many other countries had detrimental effects on international trade and the Italian economy as a whole. Hence the lesson of smarter governance and international cooperation was a strong message throughout that time, with the ability of a more adaptive government and better global framework Italy could have forgone the depression altogether.
V. CONCLUDING REMARKS
Financial markets are at the heart of modern economies and there can be no doubt that the financial innovations and change since the 1929 have contributed positively to the global and state economies on both a framework and social level. Through discussing the stock market crash and period following we have came to significant conclusions surrounding the lessons learnt. It is prominent that the global economy requires a sound financial infrastructure that gives dependable, significant and consistent signals to all global participants, as well as adequate recognition for the central role financial institutions and central banks play. Thus, nations need to ensure a financial market infrastructure that inspires confidence through transparency. In addition, macroeconomic policy, especially monetary policy, now pays more attention to financial stability issues, with a global perspective. Although it is has taken years for the global frame work to be established, no doubt the blue-prints will continue to change and improve, but the 1929 stock market crash set off a new wave. Thus, inventing a contemporary way of thinking, governance and institutionalization is very essential.
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