http://news.bbc.co.uk/2/hi/business/7656949.stm
Lessons from the 1929 stock market crash By Steve Schifferes Economics reporter, BBC News WHAT HAPPENED? * In October 1929 shares on Wall Street fell sharply following a speculative boom during the "Roaring Twenties". * In two days the Dow Jones industrial average fell by 25% (ending on Black Tuesday, 29 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. WHAT WAS THE CAUSE? Debates continue over the causes of the Wall Street crash. With stocks rising four-fold over the previous decade, it had all the characteristics of a bubble, with stocks in new technologies like radio leading the way up. With lax regulation and few rules on insider trading, dealers were also able to "ramp up" shares, and holding companies built up positions in other companies without putting up any equity of their own. Individuals were also able to buy stocks on "margin" by borrowing the money against their other share holdings. Finally, political considerations - including Congress passing a highly protectionist tariff bill - also spooked the market. The central bank, the US Federal Reserve, had also held interest rates unusually low for several years in order to aid the UK Sterling, which had returned to the gold standard. WHAT WAS THE IMPACT? The Wall Street crash corresponded to a sharp decline in US economic output, which eventually spread around the world. The US economy shrank by a third, and unemployment reached 25%, with many more workers on short hours. In addition, 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. 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. Most observers believe that economic policy-makers made the economic downturn worse by adopting tight money policy and balanced budgets as the crisis worsened. International trade also shrank as the US went off the gold standard and erected high tariff barriers to prevent foreign imports. WHAT SOLUTIONS WERE TRIED? Initially the authorities tried to rebuild confidence in markets by making reassuring speeches, with President Herbert Hoover telling Americans that the US economy was fundamentally sound. Only a shake-out of workers from industry would ultimately restore prosperity, it was argued. Private charity was relied on to help the victims of the slowdown. Everything changed after Franklin D Roosevelt was elected president in 1932, and the US government intervened to provide unemployment relief, to stabilise 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 Roosevelt administration had less success in reviving economic growth and business confidence remained weak. HOW WAS THE SITUATION 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. 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 blacks were pulled into the workforce to replace the millions drafted into the military. At its peak, the US government was borrowing half the money needed to finance the war, while half was raised by taxes. WHAT LESSONS ARE THERE FOR THE CURRENT CRISIS? There are three main lessons which policy makers are applying to the current crisis. The first is that financial markets, banks, and the real economy are interlinked, so that unresolved problems in one sector can spread to others. The second is that active and rapid government intervention to ease pressures on the economy is essential during times of real economic crisis. The slow and probably wrong-headed response of the US government and central banks in the 1930s made the downturn more severe. Thirdly, there is the danger of a policy vacuum during the inter-regnum. In 1933 the US banking crisis grew much worse during the five months between the election of a new president and his taking office. That may explain why both candidates endorsed the Bush administration's rescue plan despite some misgivings. Story from BBC NEWS: http://news.bbc.co.uk/go/pr/fr/-/2/hi/business/7656949.stm Published: 2008/10/09 22:39:10 GMT © BBC MMVIII
