The Stock Market: Another 1929?
CALBRAITH, JOHN KENNETH
The Stock Market: ANOTHER 1929? By John Kenneth Galbraith The concern over the behavior of the stock market is, in the last analysis, a concern over speculation Speculation, in turn, is the...
...In the stock market, the volume of brokers' loans is a valuable index of the amount of speculation...
...The economy is also less brittle than in 1929...
...In land speculation, this is usually accomplished by trading in binders or on the basis of down payments: in the stock market, by margin trading...
...In the light of this history, it may not be too much to hope that the financial community would take the lead in resisting a new outbreak of speculation...
...No one would have been in doubt as to who was to blame...
...In October, this doctrine was proved in error...
...of 1928-29, the Florida land boom of the mid-Twenties, the Iowa land boom following World War I, the various railroad and land booms of the last century, the classic Mississippi and South Sea Bubbles—have, in the beginning, been grounded on some element of reality...
...By doing so, they keep prices going up...
...The banking structure, as the result of sad experience, firmer and more flexible banking laws, and (particularly) deposit insurance, is also much stronger...
...By 1929, 5-million-share days on the New York Stock Exchange were commonplace...
...It is reasonable to think of a reduction in spending of $3 or $4 billion—out of a total disposable income of $82.5 billion—as the result of the crash...
...Yet, within the last few months, there has been an influx of newcomers into the market...
...The vulnerable expenditure is now considerably less important than twenty-five years ago...
...it can only be collapsed...
...When prices level out...
...There were short rallies during the days of the crash, each of which led to widespread hope that the worst was over...
...Only after the crash did all the important indexes turn down—and in earnest...
...This is a rather elementary precaution...
...The mood which speculation engenders is also much the same in different episodes...
...This was the reality behind the 1928-29 stock-market boom...
...The interest in these enterprises was almost exclusively in their promise of capital appreciation...
...Insull, and Associated Gas & Electric...
...That this occurred was the current view of the Federal Reserve Board and of President Hoover...
...Securities speculation, even at its most extreme, is very much a minority enterprise...
...The man who is seeking capital gains has no interest in a stable market...
...Between 1929 and 1948, the share of total personal income going to the 5 per cent of the population with the highest incomes dropped from nearly a third to less than a fifth...
...There should, also, be a keen suspicion of whatever are the currently fashionable remedies...
...in those more unsophisticated days, it was merely said that there weren't enough to go around...
...the responsibility would have been squarely on the Federal Reserve...
...The problem of speculation is essentially that of minimizing its social consequences...
...the 5 per cent of the population with the highest incomes then disposed of approximately a third of all personal income...
...on January 1, 1929, it was $5.7 billion...
...The American people have a way of looking for someone on whom they can blame their misfortunes...
...This is more than in any recent period since 1929—when prices reached 1.9 times book value—and 1936-37, when, following a long period of deflation of book values, stocks sold at 1.8 times book...
...The person who held securities on margin at this interest-cost and dividend-return was obviously interested only in speculative gain...
...It is interesting to recall that early in 1929 there were suggestions that the country was running out of common stocks...
...Compared with the $8 billion of brokers' loans in the late days of the 1929 boom, the total of late has been around $1.6 billion...
...Economic activity is likely to be adversely affected...
...Prices break...
...Comparisons of the averages of share prices over so long a period are largely meaningless...
...High-bracket expenditure in general, and expenditure by dividend recipients in particular, is especially vulnerable to stock-market movements...
...Accordingly, there was a very strong tendency to postpone action...
...These measures include the policing of trading and the prevention of market manipulation, provision for full disclosure on new promotions, prevention of holding-company pyramiding, and others...
...To repeal the capital-gains tax would also make available for the purchase of securities funds now paid in taxes...
...Wall Street, as a deas ex machina, has always been much esteemed...
...If this is so, when they sell they will be right back in the market as buyers...
...The boom will continue as long as the supply of new people with new money lasts...
...The volume of brokers' loans in this period reflected the speculative interest...
...In short, repeal, it is presumed, would bring more sellers...
...A man would hardly pay these rates to enjoy yields on stock which, by the autumn, averaged a little over 3 per cent on representative industrials...
...This was in the setting of a far smaller economy...
...It is not accurate, however, to suggest that everyone was playing the market...
...As with clothes and cars, ideas on financial policy have a marked style factor...
...Between October 22 and November 13, the value of industrial shares fell by between a third and a half...
...Even after a speculative rampage gets well under way, it can still be stopped...
...So far, there has been no close parallel to the investment-trust and holding-company promotions of Goldman Sachs...
...They were not "locked in...
...The livelihood of people to whom the market is a remote phenomenon may suffer...
...A request to Congress to investigate and recommend legislation would also have had a signal effect...
...In fact, the end alwavs comes for the same fundamental reason: The supply of new buvers has become inadequate to keep prices going up...
...The Securities and Exchange Commission, aided by a more mature business sense on the part of the exchanges, members and dealers, has prevented the wholesale market-rigfiing and fervent salesmanship of the earlier period...
...If speculative tendencies persist, more drastic measures invoking the tax power should be contemplated...
...Market discussion has turned increasingly on the prospect for capital gains...
...At least four important consequences must be attributed to the 1929 crash: ? 1. A sharp reduction in consumer spending...
...Others then sell to avoid losses...
...More important, once a boom is well started it cannot be arrested...
...The more serious consequences are from the breaking of the speculative bubble...
...During 1929, the investment trusts marketed an estimated S3 billion worth of securities...
...has been investigating the big bull market which, for the past sixteen months, has dominated the Stock Exchange...
...At about the same time, Charles E. Mitchell, then Chairman of the National City Bank, declared that the "industrial condition of the United States is absolutely sound" and complained that too much attention was being paid to the volume of brokers' loans...
...It was taken between January 1946 and February 1947, when the danger of speculative boom in the market was far less than at present...
...A word is in order on the lessened susceptiCONTIMftt US NI \ T r,ci CONTINUED bility of the economy to disruptive news from the stock market...
...The Dow-Jones industrials dropped from 327 to 199...
...In 1929, there was also a great surge of activity on the out-of-town exchanges and on the Curb Exchange...
...Those who argue that the capital-gains tax has made stocks scarce assume that the present owners yearn, when they sell, to hold Government securities or cash...
...This was magnified by the holding-company and investment-trust structure...
...Perhaps there is a case against the taxing of capital gains...
...They increased by another third in the first eight months of 1929...
...The Florida climate, on which the Florida boom was based, is very good most of the time...
...Measured against any previous experience, at least since the South Sea Bubble, the securities speculation of 1928 and 1929 was one of remarkable magnitude...
...All—the stock-market boom The Senate Banking and Currency Committee, under the chairmanship of J. William Fulbright (D.-Ark...
...But the critical feature of the speculative episode is that, after a time, speculation acquires a dynamic of its own...
...John Law...
...In each case, however, the recovery was followed by a further slump...
...But tax considerations enter into most modern transactions, and recent investigations of the New York Stock Exchange have cast doubt on the extent to which higher-bracket investors are affected by tax considerations...
...Although there is a legend to the contrary, the Government and the Federal Reserve System, with the powers then available to them, could have brought the boom to an end at any time in 1928 and 1929...
...Obviously, this belief did not predispose Coolidge to any very strenuous steps to halt the boom...
...The great speculative episodes of the past have all had certain features in common...
...Temporary setbacks may actually encourage more people to come into the market on the assumption that they are picking up bargains...
...A stern statement that values had reached nonsensical levels, that the volume of brokers' loans was indefensible, that the current speculation was against all public policy, and that unremitting moral pressure would be placed on banks that loaned money for speculative purposes, would probably have been sufficient...
...As in the Twenties and in other periods of great speculative optimism, we are having a sizable wave of mergers...
...There should be specific and reiterated warning about the danger of runaway speculation to the economy and the participant, and specific and reiterated urging to people to buy good bonds...
...And the stock market did have its effect on the economy...
...the English promoter, precipitated the crash of 1929...
...Accordingly, he will seek some way of trading which gives him the CONTINVn ON MM r MARKET capital gain but avoids his putting up the capital...
...Average dividend yields were down to 3.99 per cent at last year's high, as compared with 3.15 per cent at the 1929 high...
...Galbraith is also the author of a new study of the 1929 stock-market disaster, entitled The Great Crash, which will be published next month by Houghton-Mifflin...
...And there is the power of the latter, under the Securities and Exchange Act of 1934, to specify margin requirements and, if necessary, to raise them to 100 per cent...
...The stock-market crash was an event of original and grave importance...
...there have been only one or two such days in recent times...
...When the market has been stable (or declining) for a substantial period, margin trading should again be allowed...
...In any case, the effect of this reform on the supply of securities and their price should probably be regarded with a measure of amiable skepticism...
...By autumn, it was some $8 billion...
...Losses in the market forced a retrenchment in spending from other income...
...Under extreme circumstances, all else is forgotten...
...be sells...
...The 1929 experience is not reassuring...
...It would, as plausibly and perhaps more plausibly, bring more buyers...
...The measures which have made the economy less vulnerable to cyclical disturbance -—ranging from Social Security to a better tax s\stem?are familiar...
...One of the most engaging aspects of economics is the tendency for proposals for economic reform to culminate in suggestions for tax reduction...
...For some time, there has been much faith in what could be accomplished in the control of speculation by monetary policy...
...Industrial activity was rising in the late Twenties, as were corporate earnings...
...Bank failures had a further depressing effect on both personal and business spending...
...The corporate structure, in the absence of vast holding-company and investment-trust promotions, is also less vulnerable now...
...It might now extend its activities to include education in the principles of sound ownership...
...There is a distortion of economic values during the period of speculation itself...
...Indeed, until the crash occurred, it was generally assumed that business was very good...
...Shortly before the 1929 crash, Professor Irving Fisher of Yale University, a notable figure in American economic thought, reached his memorable conclusion that stocks were on a new high plateau...
...But the amount has been rising, and it seems possible that there is now more borrowing outside the market on securities collateral than in earlier periods...
...Such is the pure model of the speculative orgv...
...Most important, since 1929 there has been a general strengthening of both the moral and legal authority of the Federal Reserve System...
...There are other commonplace features...
...The economic consequences of a speculative boom are twofold...
...this, in turn, has created a shortage of stocks...
...So does the structure of public restraints...
...There was a strong tendency at the time, and one that is still reflected in economic literature, to minimize the general economic significance of the stock-market misfortunes...
...By January 1, 1928, it had reached $3.5 billion...
...There are two difficulties in taking action after a speculative boom is well under way...
...Such action must contend with the process of reassurance which, as noted, is the normal concomitant of the boom and which insists that all is well...
...The solution lies much more in prevention than in control—a point of considerable practical importance at the moment...
...Prices of industrial securities on the New York Stock Exchange approximately doubled between the beginning of 1927 and the beginning of 1929...
...In 1928, 920 million shares were traded on the New York Stock Exchange (in 1929, 1,125 million shares), as compared with only 573 million last year...
...An estimated 600,000 accounts were for margin trading...
...Attention shifts from making goods to making money...
...Funds to finance margin trading were attracted to New York from all over the world...
...The Government should make this position clear in every other possible way...
...visiting Louisiana and the lower Mississippi after 238 years, would find much to substantiate the brilliant prospects which were painted to French investors in 1717...
...The rate on brokers' loans during 1929 varied from a minimum of 5 per cent to a maximum (briefly) of 20 per cent...
...The most important source of strength, in this respect, is the leveling up of personal incomes during the last quarter-century...
...An observer noted that, at the height of the South Sea Bubble, "Statesmen forgot their Politics, Lawyers the Bar, Merchants their Traffic, Physicians their Patients, Tradesmen their Shops...
...The occupational disease of the speculator is acute uneasiness...
...With the crash, this lending came to an end...
...Very recently, the notion that the capital-gains tax is responsible for high values and at least incipient speculation has been in vogue...
...Efforts to enforce a high market rate may have had some effect in depressing ordinary, non-speculative business activity, which is more sensitive to such costs...
...The scale of the 1929 speculation was greater than anything we have yet witnessed...
...There were hundreds of other such statements, all received with approval...
...3. The value of bank assets was drastically reduced and the vulnerability of banks to failure thereby enhanced...
...By John Kenneth Galbraith The concern over the behavior of the stock market is, in the last analysis, a concern over speculation Speculation, in turn, is the purchase, possession or sale of an asset with a view not to use of income but to realizing a capital gain...
...Rates on the call market ranged from 5 to 20 per cent...
...To avoid insolvency, they were forced to retrench drastically on both current and investment spending...
...when participation was assumed to be growing by leaps and bounds, the number of margin accounts increased by only a little over 50.000...
...In numerous cases, these fragile corporate structures collapsed following the crash, forcing further retrenchment...
...Since the speculator is interested only in capital gains, he finds it onerous to have to put up the whole purchase price...
...The stocks comprising the Dow-Jones industrial average have recently been selling at 1.6 times the book values of the companies...
...Foreign countries were forced to curtail their imports from the United States with a further depressive effect on markets for wheat, cotton, tobacco and other export crops...
...American Founders...
...More than half of the latter was provided by non-banking corporations and by individuals who were attracted by the high rates in the call market...
...One of the Fulbright Committee's first and best informed witnesses was John Kenneth Galbraith (cut at right), Professor of Economies at Harvard University and author of .4 Theory of Price Control and the recent American Capitalism...
...Member firms of 29 exchanges reported 1,548,707 customers in 1929, of which 1,371,920 were with member firms of the New York Stock Exchange...
...The decline in general economic activity between June and October of 1929 was slight...
...The crash was held to have followed, rather than preceded, the general downturn in business, and it was also said to have had relatively little effect on business...
...On the other hand, there are resemblances which are certainly interesting and possibly disturbing...
...The extent of popular interest in the market, however, was almost certainly greater in 1929 than of late...
...in the latter, he developed the widely discussed theory of "countervailing power...
...To immobilize property because of the tax cost of selling it does not, at first glance, seem desirable...
...Debtors of Quality their Creditors, Divines the Pulpit, and even the Women themselves their Pride and Vanity...
...It would have fallen—precipitately...
...As a result, prices have been rising and yields declining...
...These latter were often paying interest on upstream bonds from the dividends of operating companies...
...One purpose of the foregoing step is to make wholly unambiguous the intention of the Government to hold securities speculation in check...
...This would include stern warnings on the dangers that await the amateur speculator, reminders of past misfortunes and of the tendency of markets that have gone up to spectacularly come down the same way...
...There is no doubt, however, as to the preoccupation with speculative gains...
...Should it be needed, a moderate (or severe) tightening of money rates would get things under control...
...the bust is alwavs a good deal more \ in-lent than the boom...
...The exchanges and their members have, perhaps, the most to lose from a new succession of boom and bust...
...The prime need is to act early rather than late...
...During the early months of 1929...
...Many of the latter, for all practical purposes, became unsalable...
...The levels at which the market steadied in mid-November were, of course, far above those reached later in the Depression...
...The capital-gains tax has "locked in" the securities in their present ownership...
...Stock-exchange firms which take a long-term view of their situation should be alert to discourage a resurgence of popular speculative activity...
...In our society, moreover, some responsible officials will always be carried away by the assurances and will thus be opposed to action...
...It would be a part of wisdom, in the future, to avoid risking a similar cycle of speculation and collapse...
...Reassurance—explanations as to why things are sound?soon partakes of the proportions of a minor industry...
...The recent boom in the stock market differs in important respects from that of 1928 and 1929...
...Because of more conservative dividend policies in recent times, the ratio of prices to earnings remains rather more favorable than in 1929...
...4. The market crash disrupted the foreign balance of payments...
...Finally, there are the new controls and the chance that they will keep speculation in rein...
...This atmosphere is the crucial aspect of the problem posed by speculation...
...Had the Federal Reserve System in 1929 taken the steps mentioned above, the market would not have leveled off...
...If it weren't incipient, nothing much would or could be done...
...Thus, the New York Stock Exchange for some years has been endeavoring to widen the public interest in the ownership of securities...
...Because they are rising and money can be made, more and more people are encouraged to try and get a share in the capital gains...
...Should there be a resumption of the upward movement of the past year in the weeks or months ahead, the Federal Reserve should be pressed to put trading on a cash basis by raising margin requirements to 100 per cent...
...The fact that the present boom may be in only a relatively incipient stage should not, accordingly, be a reason for advocating inaction...
...Previously during the boom there had been bad breaks in the market—especially during March 1929 when there was a brief money crisis —but the market in each instance recovered...
...The crash had a general effect on confidence and a direct effect on the ability of corporations to raise funds through new issues...
...What becomes important is the single fact that prices are rising...
...At the beginning of 1927, the total of brokers' demand loans was $2.5 billion...
...Perhaps there might be some organized effort to encourage people to buy—if they must buy—with a view to earnings...
...There should be no doubt that the stock-market speculation in 1928 and 1929 and the ensuing collapse contributed significantly to the severity of the Great Depression...
...It brought an end to spending from stock-market gains...
...Taxes were being reduced...
...This, in the years preceding, had been kept precariously in balance by private foreign lending...
...2. A sharp reduction in business investment...
...Railroad stocks fell less and the new investment-trust securities much more...
...The market loses touch with reality...
...These views do not stand scrutiny...
...The underlying economic position also differs...
...It is less vulnerable to a general slump, and less subject to disturbance from the market...
...The volume of trading then was much higher...
...In his memoirs, Herbert Hoover recalls that, shortly before leaving the White House in 1929, President Coolidge expressed the view that conditions were "absolutely sound" and that stocks were "cheap at current prices...
...The share of rent, interest and dividends in total income dropped from just over 15 per cent to just under 9 per cent...
...In 1929, expenditures by consumers in the higher-income brackets accounted for a substantial share of total outlays...
...The end may, in practice, be attributed to various causes: The 1926 hurricanes were thought to have ended the Florida boom, and many ha\e suggested that the failure of Clarence Hatry...
...Because of the helter-skelter rush to get out...
...Perhaps they yearn to own other shares with, as they believe, better prospects for appreciation or earnings...
...In March of 1929, the mere news that the Federal Reserve Board was holding extraordinary meetings in Washington—presumably to discuss the market, although no statement or action ever materialized—was sufficient to cause wholesale liquidation...
...There was extensive public interest and a substantial public participation...
...a repeal or reduction of the capital-gains tax would release these securities and bring down the market...
...By the time of the crash, new companies were being organized at the rate of one a day...
...In the sixteen months ending last December 31, the prices of industrial shares (as measured by Dow-Jones averages) increased by 54 per cent, as compared with 78 per cent in the sixteen months preceding the 1929 crash...
...And the fundamental problem of containing a speculative orgy, once it is well launched, remains essentially unsolved...
...Presumably some people, now out of the market, would be attracted in by the prospect of tax-free gains...
...This, naturally enough, did not deter speculators who were getting up to 200 or 300 per cent return in capital gains...
...Any suggestion that values are unreal ¦—that things are less than wonderful—is fiercely resisted...
...Though the crash had little effect on the life or spending habits of the great mass of consumers, it was capable of affecting in marked degree the outlay of the well-to-do...
...Stocks became suddenly, miraculously, and most disastrously abundant...
...It is not so much one in which people are fooled as one in which they insist on fooling themselves...
Vol. 38 • March 1955 • No. 13
