The Wall Street Crash of October 1929 and the causes of the Great Depression

What this dot point is asking

NESA expects you to explain why the New York stock market crashed in October 1929 and how the Crash became the Great Depression of the 1930s. Strong answers integrate the 1920s bull market and its speculative excess, the structural weaknesses of the real economy, the brittle banking system, the policy failures of the Federal Reserve and Treasury, and the international transmission through the gold standard.

The answer

The 1920s bull market

Stock prices rose modestly through the mid-1920s and then accelerated. The Dow Jones Industrial Average rose from around 100 in 1926 to 191 on 3 March 1928 and to its peak of 381 on 3 September 1929, a near-quadrupling. Trading volume rose from around 230 million shares in 1923 to 1,125 million in 1928.

The boom rested on three legs:

Margin. Brokers' loans (the credit financing margin purchases) rose from 1 billion dollars in 1920 to 8.5 billion by September 1929. Margin requirements were 10 per cent; a small fall in stock prices wiped out leveraged positions.

Investment trusts and holding companies. Pyramided structures like Samuel Insull's utility empire and Goldman Sachs Trading Corporation magnified gains and losses. The Insull empire collapsed in 1932 owing investors around 3 billion dollars.

The Florida real estate bubble (1925 to 1926) and its collapse had been a dress rehearsal. Investors moved capital from collapsed Florida real estate into rising stocks.

The Federal Reserve raised the discount rate from 3.5 to 5 per cent in February 1929 and to 6 per cent on 9 August 1929 to slow speculation. The hike came too late to deflate the bubble gently and too soon to be absorbed by the real economy.

The Crash

The market peaked at 381 on 3 September 1929 and drifted sideways through September. The fall accelerated in October.

Black Thursday, 24 October 1929. 12.9 million shares traded (around three times normal volume). Prices fell around 11 per cent at the open. A bankers' pool led by Charles Mitchell of National City Bank stepped in around midday and stabilised the close, with the Dow down only around 2 per cent.

Black Monday, 28 October 1929. The Dow fell 13 per cent in a day. The bankers' pool did not return.

Black Tuesday, 29 October 1929. 16.4 million shares traded (a record that stood until 1968). The Dow fell another 12 per cent. Around 14 billion dollars of paper wealth was destroyed in two days, around 30 billion dollars over two weeks.

The slide. The Dow fell from 381 on 3 September 1929 to 198 on 13 November 1929 (around 48 per cent), then rallied to 294 by April 1930, then fell continuously to its low of 41 on 8 July 1932. Total decline from peak to trough was around 89 per cent. The 1929 peak was not regained until 1954.

From crash to depression

A stock crash is not automatically a depression. The Crash became the Depression through three channels.

The real economy. Industrial production fell around 46 per cent from 1929 to 1933. Real GDP fell around 30 per cent. Investment collapsed from around 16 per cent of GDP to around 4 per cent. Unemployment rose from around 3 per cent (1929) to around 25 per cent (1933, around 13 million people).

The banking system. The American banking system had over 25,000 banks, mostly small, unbranched, and state-chartered. Around 9,000 banks failed between 1930 and 1933, mostly in the rural Midwest and South.

Key failures:

• Caldwell and Company, Tennessee, 7 November 1930, the largest bank failure to that date.
• Bank of United States, New York, 11 December 1930, with deposits of around 200 million dollars.
• The Kreditanstalt, Vienna, May 1931, propagating the panic to Central Europe.
• The Detroit banking holiday, 14 February 1933.

The Federal Reserve, designed in 1913 to be a lender of last resort, did not act. The money supply (M2) fell around 30 per cent from 1929 to 1933. Friedman and Schwartz (A Monetary History, 1963) argue this was the decisive failure.

Policy. The Hawley-Smoot Tariff (17 June 1930), Hoover's signature trade measure, raised average tariffs to around 60 per cent. Over 1,000 economists signed a public letter opposing it. Around 28 countries retaliated. World trade fell around 65 per cent between 1929 and 1934. The Revenue Act of 1932 raised income, estate, and excise taxes in the middle of the slump, deepening the contraction.

The international transmission

The gold standard linked currencies to fixed parities. A country running a balance of payments deficit lost gold, contracted its money supply, and forced deflation; one running a surplus accumulated gold but did not necessarily expand. The system transmitted the American shock abroad.

American capital flows to Europe reversed after 1928 as Wall Street drew investment home. Germany, dependent on short-term American loans under the Dawes (1924) and Young (1929) Plans, defaulted on reparations after the Hoover Moratorium (June 1931) and faced the collapse of the Danatbank in July 1931.

Britain left gold on 21 September 1931. The Sterling Area emerged. The United States held on to gold until April 1933, when Roosevelt's Executive Order 6102 (5 April 1933) banned private holding and the dollar was devalued from 20.67 to 35 dollars per ounce on 31 January 1934.

Historiography

John Kenneth Galbraith (The Great Crash 1929, 1955) is the foundational popular account; emphasises speculative mania and policy denial.

Milton Friedman and Anna Schwartz (A Monetary History of the United States 1867-1960, 1963) argue the Depression was made by the Federal Reserve's failure to prevent a 30 per cent collapse in the money supply.

Charles Kindleberger (The World in Depression, 1973) argues the absence of a hegemonic stabiliser (Britain was past it, the United States was not yet ready) is the key.

Barry Eichengreen (Golden Fetters, 1992) treats the gold standard as the central international mechanism.

Ben Bernanke (Essays on the Great Depression, 2000) integrates the credit channel and the gold standard.

Common exam traps

Treating the Crash as the cause of the Depression. The Crash exposed the structural weaknesses; bank failures, monetary contraction, and protectionism made them catastrophic.

Confusing Black Thursday with Black Tuesday. 24 October was the panic day; 29 October was the larger fall.

Forgetting the Fed's role. Friedman's monetary critique is now consensus; the Federal Reserve allowed money supply to collapse by around 30 per cent.

In one sentence

The Wall Street Crash of October 1929 (peak Dow 381 on 3 September 1929, Black Thursday on 24 October with 12.9 million shares traded, Black Tuesday on 29 October with 16.4 million, trough 41 on 8 July 1932) exposed the 1920s asset bubble and the structural weaknesses of the American economy and was transformed into the Great Depression through the collapse of around 9,000 banks (1930 to 1933), the Federal Reserve's failure to prevent a 30 per cent fall in money supply, Hawley-Smoot's 60 per cent tariffs of 17 June 1930, and the international gold standard's transmission of the shock abroad.