What Caused the Stock Market Crash of 1929?

The decade, known as the "Roaring Twenties," was a period of exuberant economic and social growth within the United States. However, the era came to a dramatic and abrupt end in October 1929 when the stock market crashed, paving the way into America's Great Depression of the 1930s.

In the years to follow, economic upheaval ensued as the U.S. economy shrank by more than 36% from 1929 to 1933, as measured by Gross Domestic Product (GDP). Many U.S. banks failed, leading to a loss of savings for their customers, while the unemployment rate surged to over 25% as workers lost their jobs.

Key Takeaways

  • In October of 1929, the stock market crashed, wiping out billions of dollars of wealth and heralding the Great Depression.
  • Known as Black Thursday, the crash was preceded by a period of phenomenal growth and speculative expansion.
  • A glut of supply and dissipating demand helped lead to the economic downturn as producers could no longer readily sell their products.

What Is an Economic Depression?

Black Thursday

The crash began on Oct. 24, 1929, known as "Black Thursday," when the market opened 11% lower than the previous day's close. Institutions and financiers stepped in with bids above the market price to stem the panic, and the losses on that day were modest, with stocks bouncing back over the next two days.

However, the bounce was short-lived since the following Monday—now known as Black Monday—the market measured by the Dow Jones Industrial Average (DJIA) closed down 13%. The next day, Black Tuesday, the Dow, which contains some of the largest companies in the U.S., fell another 12%.

Before the crash, which wiped out both corporate and individual wealth, the stock market peaked on Sept. 3, 1929, with the Dow at 381.17. The ultimate bottom was reached on July 8, 1932, where the Dow stood at 41.22. From peak to trough, the Dow experienced a staggering loss of 89.2%.

Although the price of many large, blue-chip stocks declined, smaller companies suffered, even more, forcing companies to declare bankruptcy. Many speculative stocks were delisted from stock exchanges. It was not until Nov. 23, 1954, that the Dow reached its previous peak of 381.17.

Before the Crash: A Period of Phenomenal Growth

In the first half of the 1920s, companies experienced a great deal of success in exporting to Europe, which was rebuilding from World War I. Unemployment was low, and automobiles spread across the country, creating jobs and efficiencies for the economy. Until the peak in 1929, stock prices went up by nearly 10 times. In the 1920s, investing in the stock market became somewhat of a national pastime for those who could afford it and even those who could not—the latter borrowed from stockbrokers to finance their investments.

The economic growth created an environment in which speculating in stocks became almost a hobby, with the general population wanting a piece of the market. Many were buying stocks on margin—the practice of buying an asset where the buyer pays only a percentage of the asset's value and borrows the rest from the bank or a broker—in ratios as high as 1:3, meaning they were putting down $1 of capital for every $3 of stock they purchased. This also meant that a loss of one-third of the value in the stock would wipe them out.

Overproduction and Oversupply in Markets

People were not buying stocks on fundamentals; they were buying in anticipation of rising share prices. Rising share prices brought more people into the markets, convinced that it was easy money. In mid-1929, the economy stumbled due to excess production in many industries, creating an oversupply. Essentially, companies could acquire money cheaply due to high share prices and invest in their own production with the requisite optimism.

This overproduction eventually led to oversupply in many areas of the market, such as farm crops, steel, and iron. Companies were forced to dump their products at a loss, and share prices began to falter.

Global Trade and Tariffs

With Europe recovering from the Great War and production increasing, the oversupply of agricultural goods meant American farmers lost a key market to sell their goods. The result was a series of legislative measures by the U.S. Congress to increase tariffs on imports from Europe. However, the tariffs expanded beyond agricultural goods, and many nations also added tariffs to their imports from the United States and other countries. The overproduction, oversupply, and higher prices due to tariffs had devastating consequences for international trade. From 1929 to 1934, global trade plummeted by 66%.

Excess Debt

Margin trading can lead to significant gains in bull markets (or rising markets) since the borrowed funds allow investors to buy more stock than they could otherwise afford by using only cash. As a result, when stock prices rise, the gains are magnified by the leverage or borrowed funds.

However, when markets are falling, the losses in the stock positions are also magnified. If a portfolio loses value too rapidly, the broker will issue a margin call, which is a notice to deposit more money to cover the decline in the portfolio's value. If the funds are not deposited, the broker is forced to liquidate the portfolio.

When the market crashed in 1929, banks issued margin calls. Due to the massive number of shares bought on margin by the general public and the lack of cash on the sidelines, entire portfolios were liquidated. As a result, the stock market spiraled downwards. Many investors were wiped out, and the Federal Deposit Insurance Corporation (FDIC), which guarantees depositors' funds, didn't exist back then. Many Americans began withdrawing their cash from banks while the banks, which made too many bad loans, were left with significant losses.

The Aftermath of the Crash

The stock market crash and the ensuing Great Depression (1929-1939) directly impacted nearly every segment of society and altered an entire generation's perspective and relationship to the financial markets.

In a sense, the time frame after the market crash was a total reversal of the attitude of the Roaring Twenties, which had been a time of great optimism, high consumer spending, and economic growth.

Article Sources
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