Lesson Plan - Get It!
The 1920s had been the most prosperous decade in American history.
- So, how could it end with the worst financial collapse in history?
The Roaring '20s were a decade of excess. A mass consumer culture started to form around readily available credit.
Similar to a credit card, the ease with which credit could be acquired at places like department stores meant people could build incredible debts in a variety of ways. This was the first time it was easy to buy things and be able to pay for them later.
People began to move from rural America into the cities, and greater agricultural innovation led to a massive surplus in food which, while hurting farmers, made urban areas grow even more quickly.
The booming stock market encouraged more Americans than ever before to invest in stocks, which were seen as being as safe as keeping money in the bank.
While the stock market did not affect every American in the nation, it had traditionally been a marker for the economic health of the nation.
The primary reason stock market crashes occur is because of speculation.
People began to bet that stocks were going to keep going up at the incredible rate they had been. Their speculation on the short-term expectations of the market brought high stakes into the American financial system.
Steel production was down, cars sales went down, and fewer buildings were being constructed; however, people kept investing in these companies. As the economy began to slow down, investment did not.
The detachment of the stock market from the actual economy had formed a "bubble" that was going to burst at some point.
The market was beginning to show signs of downturns in early 1929, but increased investment by bankers artificially maintained stock prices for many months of the year.
In the past, wealthy Americans would inject their own money into the financial system in order to stop a panic. If the stock exchange began to falter, everyday Americans would begin to pull their money out of banks and make the situation worse.
Image by Pacific & Atlantic Photos, Inc., via the Library of Congress, has no known restrictions on publication.
After the crash of the London Stock Exchange in September, it became clear the entire world was prospering only superficially.
On October 24, known now as Black Thursday, the stocks trading on the New York Stock Exchange lost an average value of 11%.
This incredible decline, started by Americans selling off their stocks out of caution, began the rapid decline of the stock market. Again, wealthy bankers attempted to buy stocks like U.S. Steel at well above market price in order to raise market value and introduce stability.
If you have ever seen people rush grocery stores for milk and bread before a snow storm, you understand how the fear of something happening can drive droves of people to do something.
In this case, Americans sold out of the stock market and tried to withdraw all their money out of banks.
At this time, bank deposits were riskier than they are today because they were not insured by the U.S. government. Once banks were drained of funds, many went out of business.
Americans lost their savings, their bank deposits, and any investments they had made. Unfortunately, many of these same people were already in debt due to all the available credit they had been given.
- Why might the investments of the wealthiest Americans into the falling market not have given the average American confidence in the financial system?
Image from The National Archives, via Wikimedia Commons, is in the public domain.
The psychological impact of Black Thursday pushed the market to fall over 30% in value.
Read this excerpt from the article Market Crash Psychology: You Actually Have Time Before the Selloff, by Duino Schiappapietra on Many Stories, to understand how a crash becomes almost inevitable once it starts:
When the market is already down 30% or more people start to seriously worry about what is going to happen next.
"Am I going to lose even more money?"
Once all chances of making a profit are lost, investors become really concerned about saving what's left.
The sensation of not having any degree of control on the situation, on your investments and on markets, brings to the capitulation.
After reaching their breaking point, people sell their positions at any price to avoid bigger losses.
This is what causes the market to drop 50% during crashes. It is a self-reinforcing mechanism since the more investors sell, the more prices drop, the more investors rush to sell.
The wealthy investors, who were trying to artificially prop up the market, accepted that they needed to sell out once it became clear they were going to lose more money.
Obviously, the psychology of this event was detrimental to those trading on the stock market, but it also extended to every other American.
- Why do you think that was?
- Do you think this stock market crash directly caused the Great Depression in the 1930s?
In our Got It? section, we will use what we learned to consider this!