Through the late 1920s, stock prices climbed. The Dow Jones Industrial Average rose from 63 in August 1921 to 381 in September 1929. Millions of Americans bought stock, many with borrowed money. Then in the autumn of 1929 prices fell, and kept falling.
Key idea
Stocks crashed in October 1929 (Black Tuesday, October 29). The Great Depression followed: by 1933 about a quarter of workers were jobless. Historians and economists weigh several causes: speculation and buying on margin, bank failures, a shrinking money supply, overproduction and weak demand, unequal income, and high tariffs.
Why it works
Buying on margin meant paying as little as 10 percent of a stock's price and borrowing the rest. When prices fell, brokers demanded repayment, forcing investors to sell, which pushed prices lower. The crash wiped out savings and confidence. But a crash alone need not cause a decade-long depression. What turned a downturn into the Great Depression? That is where economists disagree about the weights.
| Cause | The argument | Who stresses it |
|---|---|---|
| Bank failures and the money supply | More than 9,000 banks failed from 1930 to 1933; the money supply fell by about a third, and the Federal Reserve did not stop it | Monetarist economists (Milton Friedman and Anna Schwartz) |
| Weak demand | Spending by consumers and businesses collapsed, and nothing replaced it | Keynesian economists |
| Overproduction and unequal income | Factories and farms made more than people with modest incomes could buy; much of the gain of the 1920s went to the top | Many historians |
| Tariffs and world trade | The Smoot-Hawley Tariff (1930) raised duties; other nations retaliated and world trade shrank | Most economists count it as a cause, though they debate how large |
| Speculation and the crash | Easy credit fed a bubble; the crash destroyed wealth and confidence | Nearly all, as a trigger |
Work it through
Worked example: How margin magnifies a fall
An investor buys \$1,000 of stock with \$100 of her own money and \$900 borrowed. The stock falls 20 percent. What happens?
- The stock is now worth 0.8 × 1,000 = 800 dollars.
- She still owes the broker 900 dollars.
- Her 100 dollars is gone, and she owes 100 dollars more: a 20 percent fall cost her more than everything she put in.
Answer: She loses her whole stake and still owes money, so she must sell, which pushes prices lower.
Common mistake
Many students think the Crash alone caused the Great Depression. Most economists see the Crash as one cause among several, and they debate how much weight to give each. A sign that it was not the whole story: stocks had recovered a little by spring 1930, before the bank panics that followed.