It is our belief that in order to truly understand how our current economic situation has evolved and to decipher what to expect in the coming years, we should look first to history. What has transpired in similar circumstances in the past? What events triggered a crisis or lead to a market collapse? How did the the general public react? What were the consequences of the crisis? In that light, today we look briefly at the Great Depression. “The Great Depression” is a term, that given historical perspective will, in our opinion, no longer refer to the 1929 economic collapse in the United States, but will be used to describe what began in 2008 and is likely to continue for years to come.
Much has been written about The Great Depression. As a result, this analysis will be brief and, we hope, to the point.
A string of terrible days led to a more than 40 percent drop in the market from the beginning of September 1929 to the end of October 1929. The market continued to decline until July 1932, more than three years later, when it bottomed out, down nearly 90 percent from its 1929 highs.
Despite the Florida real estate crash, a bubble which burst in 1925, Americans were overwhelmingly bullish about the stock market. The feeling was one of “can’t lose” invincibility. The stock market was guaranteed to make everyone rich. The first world war had been won, and industrialization was resulting in previously unimaginable luxuries. It was a good time to be American.
Since the stock market was believed to be a no-risk, no-brain world where everything went up, many people poured all their savings into it without learning about the market, the underlying companies or the risks involved. With the flood of uneducated investors, the market was ripe for manipulation and fraud. Investment bankers, brokers and traders banded together to manipulate stock prices and generate large personal gains. They did this by subtly acquiring large chunks of a stock between them and trading shares back-and-forth to each other for slightly higher prices with each trade.
When the public noticed the upward progression of price on the ticker tape, the masses would jump in and buy the stock driving its price even higher. The market manipulators would then sell off their overpriced shares for a healthy profit. This process was repeated over and over as market insiders and even some dumb, but lucky, investors turned a profit by selling the manipulated, over-priced shares to someone who wanted to own a rising stock (i.e. the “greater fool” theory of investing).
Behavioral finance shows that the less an investor knows, the easier it is for him or her to be swept up in popular opinion (herd mentality). This behavior is a double-edged sword because ignorant investors are also easily spooked into panic. Both actions, joining and fleeing, have very little basis in the news or the quality of the market. Instead, the herd follows the cow that runs the fastest, trampling the market.
During the stock market craze before the Great Depression a number of academics, including Roger Babson, were predicting a crash if things didn’t “calm the hell down”. Sadly, for every Roger Babson, there many more bull-blinded market mavens guaranteeing the eternal rapid growth of the American stock market.
Babson had been predicting the crash for years. Babson was responsible for the “Babson Break”, a three percent market drop that followed his September 1929 warning – “Sooner or later a crash is coming, and it may be terrific”. That warning proved to be the beginning of the end.
The twelve-year worldwide depression came and ended only with the declaration of World War II. This stands as the worst financial blow to the USA ever. The crash itself, though large in its own right, was nothing compared to the ensuing graveyard market and devastating depression that followed.