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1929 Market Crash Cause



Many people believe in the reason why the market value of all share listed in NYSE fell by 30% is that there was an economic bubble and the stock market is irrational. However, is that the truth?
We are going to show you three different approaches to the 1929 market crash. Remember that correlation is not causation. These are just references.


Approaches:


1. There was no economic bubble before the 1929 market crash.


Irving Fisher, a famous US economist said: “prices of stocks are low.” Fisher based his projection on strong earnings reports, fewer industrial disputes, and evidence of high investment in R&D and other intangible capital.


2. There was insider trading.


In the months prior to the stock market crash of 1929, the price of a seat on the NYSE was abnormally low. Rising stock prices and volume should have driven up seat prices during the boom of 1929; instead, there were negative cumulative abnormal returns to seats of approximately 20% in the months before the market crash. At the same time, trading nearly ceased in the thin markets for seats on the regional exchanges. Brokers appear this to have anticipated the October 1929 crash, although investors in the market apparently did not recognize this information.


3. There was an economic bubble in 1929.


Sustained consumer demand relied on speculative forms of credit such as instalment payment plans. In their demand for instant gratification, the consumer bought more and more goods on credit in anticipation of future earnings that they mistakenly assumed would grow. Speculators extensively used margin loans to fund investments, allowing huge leverage to be built up.


Such loans were initially very attractive due to the low discount rates, which were reduced even further in 1927. Although the Fed changed tack from 1928, raising rates and warning US banks against making these loans, demand from speculators remained high. Most companies were highly leveraged.


When it comes to 1929, interest rates were 6%- not high enough to dampen demand for margin loans but sufficient to damage the rest of the economy. These high-interest rates also resulted in gold flows from Europe to New York, weakening US export markets.


Consumer demand was flagging as well. The declining agricultural commodity prices in the US had reduced the purchasing power of the farmers, who constituted a large part of the population.


Moreover, with 6 billion of instalment loans outstanding, instalment credit could not be explained any further, given that wages were not increasing.


Overall, you can see that judging whether there was an economic bubble in 1929 is very hard because different calculations result in different results.


References:

1. https://www.nber.org/papers/w8622
2. https://www.nber.org/papers/w12661
3. https://www.winton.com/longer-view/the-wall-street-crash-of-1929



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