January 27, 2008

Stock Market Hiccup Recalls 1929 Jitters

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Folks got a little discombobulated last week when the stock market hiccupped – the Dow Jones Industrial Average declining nearly 200 points from a 1400 high.

Never mind that the Dow was “irrationally exuberant.” A correction was long overdue.

The market steadied when Congress and the White House rushed to shower tax cuts and rebates on the populace.

That’s A-OK – but hardly necessary. The stock market has little bearing on the economy. Congressional spending gyrates spending binges.

Nonetheless, the rush of Democrats and Republicans to make nice is refreshing. They propose to shower us with goodies.

Balance Of Trade

The market adjustment recalls the ‘Great Depression’ of the 1930s -- triggered by world-wide “tariffs.” That is what Congress called taxes on imported commodities.

We call it “balance of trade” these days.

Ideally, the balance should be equal for all trading partners. However, nations are pleased when they sell more than they buy.

Our principal trading partner is China. As of last November (latest available figures) we bought $237 billion worth of goods more than we sold them. We also ran smaller trade deficits with Japan, Canada and Mexico.

Trade balances are the most significant measures of economic health. Yet, the stock market -- with its daily emphasis by the evening newscasts -- is wrongly held to be the barometer of economic health.

“Great Crash” Of 1929

Some of us with snow on the roof recall the stock market crash of 1929 that supposedly triggered the world-wide “Great Depression.”

In fact, root causes of the economic collapse were complex.

Stock markets have little effect on the over all economy. Buyers of common stock, for the most part, buy and sell to each other.

After an initial sale of stock, the issuing companies receive no benefit from resales by others. At the time of the “Great Crash,” less than one percent of adult Americans held common stocks.

With U.S. profits rising, “irrationally exuberant” investors rushed to buy common stocks. There was very little bank regulation. Loans to buy stocks that were soaring were easily available with just 10 percent cash and the other on 90 percent “margin.”

Banks joined the mania by investing their depositors’ money in high-flying sure-thing stocks.

As stocks doubled and re-doubled in market value, they were re-invested on margin in a race to become overnight millionaires.

Florida Land

The phenomenon also was occurring in real estate. The “Florida Land Boom” roared ahead in the same manner.

That decade is remembered as the “Roaring Twenties.”

Amateur market traders didn’t notice that professional “bear” investors were beginning to “sell short” – contracting to sell stock for a lower price at some future date.

The Trigger

Only the bears sensed the ultimate, depressing effect of tariffs - higher cost of imported raw materials and less profit on sales abroad.

President Herbert Hoover and a new Congress took office in March 1929. The stock market hit its then-record high of 800 on August 5.

Congress, ignorant of impending market correction, threw gasoline on the fire by scheduling debate for a new tariff bill sponsored by Sen. Smoot and Rep. Hawley.

The commodity targeted was carbide – a critical ingredient in the manufacture of industrial products.

Bears raced for the exits.

The stock market experienced its heaviest sell-off in its history on Thursday, October 24.

The New York Times bannered the story: “Worst Stock Market Crash Stemmed By Banks – Leaders Confer – Find Conditions Sound.”

Crash!

The market rallied a bit the next day.

Federal Reserve Bank trustees met all weekend and decided they needed to do nothing. The market gained a little more on Monday, but not enough to be reassuring.

When the market opened Tuesday, October 29, all overnight orders were to “sell at market.” The telegraph tape of sales quickly fell two hours behind. Telephone calls to brokers were unanswered.

A crowd of stockowners gathered on Wall Street and steps of the old U.S. Treasury building outside the Stock Exchange – waiting for scraps of information hustled out by infrequent messengers.

The Times headline blared: “Stocks Collapse In 16,410,030 Day.”

The date has gone down in history as “Black Tuesday.”

In four days of trading, the Dow-Jones Industrial stocks had fallen to just 8 percent of their pre-crash values. The country’s Gross National Product value fell from $104 billion, to $41 billion.

Black Tuesday

One of the myths about the Black Tuesday Crash was that many bankrupt investors committed suicide that day.

A London newspaper reported erroneously that 11 busted-brokers jumped from their office windows in despair.

The rumor started as the result of the suicide – witnessed by Sir. Winston S. Churchill on a visit to New York City two weeks before the crash.

October 1929 - Gathering Outside NYSE

A vice-president of the Earl Radio Corporation jumped to his death from the Savoy-Plaza Hotel. His suicide note read: “We are broke. Last April, I was worth $100,000. Today, I am $24,000 in the red.”

A week after the crash, J. J. Riordan, president of the County Trust Company, took a pistol from a teller’s cage at his bank, went to his home in downtown Manhattan, and shot himself.

The news was suppressed until after the bank closed at noon Saturday to avoid causing a run on the bank.

There is no record of jumpers during the pair of crashes, and none ever in the New York financial district.

Nonetheless, Will Rogers – a popular humorist – quipped: “When Wall Street took that tail spin, you had to stand in line to get a window to jump out of.”

Aftermath

Ironically, Congress adjourned in November 1929 without action on the suspect Smoot-Hawley Act and did not return until the Spring of 1930.

By this time, the Great Depression was well underway.

Still unaware of the damaging effect of tariffs, Congress completed action on Smoot-Hawley and passed it in the Senate by just two votes.

Inasmuch as it passed after the Great Depression was well underway, it was not realized that the debate and certain passage spooked the forward-looking stock market.

Passage of the act continued to hamper recovery. A hundred thousand companies closed.

It took years for a new science of economics to realize that tariffs, the uneven distribution of goods and Federal Reserve inaction had done the damage – not the stock market.

President Franklin D. Roosevelt took office in 1933. He closed all banks for ten days to stem panic withdrawals, outlawed gold coinage, set farm quotas and established government make-work programs (who can forget the WPA and CCC ?) to pump confidence and money into the U.S. economy.

Yet, it was not until Smoot-Hawley was scrapped, stock margins prohibited – and Americans armed for World War II – that the U.S. economy and employment returned to normal.

Lessons For Today

• Diversify your stock portfolio.
  
• Save some money in bank Certificates of Deposit, and a week of grocery money in an old sock under your mattress.
  
• Speak softly, but carry a big stick internationally.
  
• Throw out political rascals.
  
• Stay away from open windows in high places.
  

By Lindsey Wilger Williams, retired newspaper publisher and syndicated columnist