Why did the stock market collapse in 1929 Essay Example

American stock exchange (also called as the New York Stock Exchange, NYSE) To set up a big company and fuel its expenditure, costs and day to day needs such as paying staff salaries, buying new machinery and renting land a large amount of capital and money is needed. To obtain this money and capital most companies become Public limited Companies (plc's) and issue and sell shares in the stock market. Those who invest capital in the firm are issued a shareholder certificate, as they now become part owners of the firm.Even though the firm runs on the capital of these investors, the control of the firm stays in the hands of the directors who ensure that one shareholder does not gain more than 50% of the total shares so as to not lose control.

Shareholders get a return of their money either through dividends (a percentage share of the profits made by the company, which relies on how successful the firm is in its transactions) or by selling the shares at a higher price that what they were bought. The value of shares fluctuates on a day-to-day basis.If more people are buying shares than selling the value of shares increases but if more people are selling shares than buying, the value decreases. The share market was all about shareholders predicting the future prices of shares based on how well the firm was doing currently and therefore optimism, gloom and confidence were important factors, which tremendously affected the value of shares.

This market in the USA was known as the Wall Street stock market and throughout the 1920's the prices of shares were steadily increasing.In the

1920's, unemployment was low, production levels exceeded their targets, wage rises were high and prices were stable. The stock market was an easy and accessible way for ordinary people to become rich. The main aspect of the stock market, which had kept the share prices rising, was confidence of American investors in American industries, products and consumer goods. The per share capita increased tremendously, for firms like the Radio corporation of America, in five years prior to September 1929 saw their per share price increase from $11 to $114.The industrial average is the average value of shares in the top thirty companies of the stock exchange and is a decent performance indicator of the stock market.

From 1924 to 1929 the industrial average increased at such a rapid rate that many were worried that the shares would run out. At the end of 1924 the industrial average was 120 points, by 1927 it was 202 points and by 1928-year end it had reached 300. Investors thought that the boom in America was going to last for ever and there would be no recession or inflation in the economy.Investors were overconfident of the future because till 1929 the output of goods and share values was increasing rapidly however significant flaws and weaknesses were emerging in the US economy. By 1929 US industries were running out of customers who could buy their product.

The market for consumer goods was saturated as everyone who wanted a car or a fridge had one. European countries had put up their trade tariffs and barriers due to which there was a surplus of overproduced manufactured goods. In 1929, America had 6

million speculators.Speculation was a clever and sophisticated way of gambling.

Speculators did not intend to keep the shares for long. They borrowed money to purchase shares and as soon the share value increased they would sell of the share, pay back the borrowed loan and have a quick profit. Speculators also purchased shares 'on margin' which meant that they did not have to pay the full cash price of the share. American banks spent over 9 billion dollars in speculation. This form of trading worked very well only as long as the share prices were going up.

One important ingredient in the running of the stock market is trust and confidence. If investors are confident that prices will keep rising, they will invest more in order to gain from the rising prices and there will be more buyers than sellers. However, if they think prices will stop rising, they will want to cut off their losses and give away the shares and all of a sudden there will be more sellers. If this happens the share value will rapidly decrease and the entire stock market will collapse under panic and lack of optimism.This is what exactly occurred on Thursday 24th and Tuesday 29th October. On 5th September, a leading economist Roger Babson while addressing the Annual Nation Business Conference predicted the crash.

Babson predicted that a crash sooner or later was inevitable and the crash would be so devastating that factories would shut down, workers would be thrown out of their jobs, the vicious cycle would continue and the country would be plunged into a depression which would last a long time.Americans were so optimistic and

confident about the growth of the stock market that they were shook badly when sales and outputs of goods started decreasing and the share value came down. Shrewd investors thinking that a possible crisis was looming ahead started selling off their shares. This resulted in loss of confidence and panic in ordinary investors. It is always predicted that after any economy enjoys a period of massive boom it also has to suffer a period of economic decline, slump and recession. This is what exactly occurred to the American economy in 1929.

In the 1920's the farming industry had collapsed, in 1926 the construction and real estate industry which was the health sign of a leading economy had began its downturn and there was a massive decline in coal, textile and ceramic trades. In the 1920's more than 500 banks had failed due to lending too much money. The crash was coming a long way before; simply investors did not recognize the downturn early on. The economic boom in the USA was based on an increase in demand on consumer goods such as motor vehicles, washing machines, radios and telephones.

However by 1929, the demand for these goods had saturated, reached its peak and there signs that people already owned these goods and the American industries were producing more of these goods than they could sell. Also the market for these goods was targeted at the rich and middle classes. Wealth was unevenly divided in the US economy. 60% of the wealth was in hands of 5% of the population. Most people were living below poverty line.

They were not benefiting from the boom in terms of employment

because most industries were capital intensive (run by machines).At times when the rich sector had already purchased these goods, the majority of Americans who were poor could not afford to buy them. Companies desperately tried alternative ways to restore falling demand. A staggering $3 billion was spent on high-pressure persuasive advertisements but workers wages did not rise and demand kept on falling. This recessive fall in demand was not a recent development.

Through the months of September and October the share market experienced heavy falls. On 19th October over 3 million shares were traded, the industrial average fell by 12 points and margin calls were sent out.Money was demanded from investors because the stock margin had fallen down in value and could not be used as a guarantee on the repayment of loans. A sense of nervousness and gloom flooded the market. There was a high volume of trade, the ticker tape fell behind in printing the prices, investors became unaware of their share values and the industrial average fell heavily. Investors did not want to be stuck up with prices lower than what they had borrowed the shares and quickly tried to sell their shares.

On Thursday 24th and Tuesday 29th October, investors sold more than 13 million shares and 16 million shares at fraction of the price they had bought them for. Banks sold their shares to cover losses made by bankrupt speculators. Rumors spread than the senior banking officials would not stabilize the share market and in fact were selling their own shares. To ordinary investors this was like the crew of a broken ship was elbowing their own passengers to get into

the rescue boats.

A vital element destroyed was confidence.