The New York stock market crash of 1929

THE U.S. STOCK market crash of October 1929 is indisputably history's most famous financial collapse. It is evoked wherever and whenever financial sentiment becomes nervous. And policy recommendations for the following eighty years have consistently been made on the basis of analyses or presumptions of what went wrong in 1929. In particular, John Maynard Keynes's General Theory of Employment, Interest, and Money (1936) has at the heart of its diagnosis a critique not of the general operation of the stock exchange but specifically of the American market and its peculiar experience: its propensity to destabilizing and irrational speculation, which followed from the obsession of market participants with psychological rather than economic dynamics and expectations. The problem for Keynes lay fundamentally in a system of valuation in which values had no necessary or direct correspondence to long-term productivity. As a result, the American market became a casino with an inherently destabilizing quality. It was uniquely volatile because of the extent of popular participation, while more exclusive or "aristocratic" markets were less vulnerable: A conventional valuation which is established as the outcome of the mass psychology of a large number of ignorant individuals is liable to change violently as the result of a sudden fluctuation of opinion due to factors which do not really make much difference to the prospective yield; since there will be no strong roots of conviction to hold it steady. . . . The actual, private object of the most skilled investment today is "to beat the gun," as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow. . . . Even outside the field of finance, Americans are apt to be unduly interested in discovering what average opinion believes average opinion to be; and this national weakness finds its nemesis in the stock market. Extreme financial turmoil was, in other words, a specifically American malaise. Keynes's analysis became the most influential policy prescription for the middle of the twentieth century: it required government action (on fiscal policy) to stabilize overall expectations and in this way establish a predictable or, as Keynes would have called it, "conventional" framework for the valuation of economic activity and thus for the functioning of a market economy. In the 1960s, President Johnson's advisers repeatedly justified the combination of tax cuts and expansion of social spending as necessary in order to avoid a repetition of the disaster of 1929. In the mid-1970s, in the aftermath of stagnation and the first oil price shock, the world again relearned a Keynesian lesson from the experience of the Great Depression. In 1987 a seemingly exact replication of the stock market panic led to a different lesson, but again one that was historically derived: that a massive liquidity injection was needed to stop a stock market crash from becoming a generalized business depression because of the danger of a destabilization of financial institutions and of credit intermediation. This was the monetarist or Friedmanite conclusion. Again, like Keynes's analysis, it was derived from a very detailed empirical historical study of what Milton Friedman and Anna Schwartz, in their monumental Monetary History of the United States, termed the Great Contraction.2 Their emphasis was on how a stable monetary framework created the sole basis on which expectations could be reliably and predictably formulated. The Chicago or monetarist interpretation played down the significance of the October 1929 panic and explained the Great Depression in terms of the Federal Reserve's mistaken policy after 1930 in not reacting to bank failures, which produced a colossal monetary contraction (deflation).3 The year 1929 has, in short, become a standard part of the (theoretically contradictory) justifications offered by central banks for stabilizing monetary policy and by governments for stabilizing fiscal policy. More recently, the volatility of financial markets has increased due to the globalization of markets. The memory of 1929 is now invoked with each financial crisis (whatever the origin) as part of a call for a fundamental rethinking of policies aimed at financial liberalization. Helmut Schmidt, for instance, who as German chancellor in the 1970s had been obsessed by the possibility of a repeat of the Great Depression, in 1997, after the East Asia crisis, stated that "the main parallel lies in the helplessness of many governments, which had not noticed in time that they had been locked in a financial trap, and now have no idea of how they might escape." 4 The financial speculator George Soros at the same time warned of "the imminent disintegration of the global capitalist system," which would "succumb to its defects." 5 The aftermath of the subprime crisis of 2007 has produced similar reactions. Again, George Soros opined that "this is not a normal crisis but the end of an era." 6 Marcel Ospel, the chairman of the Swiss bank UBS, while defending himself from criticism after an $18 billion write-down, noted that the world was experiencing the "most difficult financial circumstances since 1929." 7 The statement is quite typical of much market sentiment in the midst of bad times, but it is also curiously erroneous. Most of the world, and particularly European countries, still had considerable financial stability in 1920, and the really severe jolt, the annus terribilis, came in 1931.