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Saturday, April 5, 2014

How the stock market crash of 1929 occurred and modern day differences

The stock market crash of 1929 was preceded by several economic warning signs. These indicators included overly inflated asset prices over several years in addition to annual wage increases of more than 15% per the following slide presentation. price inflation, Other triggers included slowing demand for U.S. agricultural products and subsequent food price deflation. The U.S. economy also seems to have been more linked to the U.K. economy at the time. This is because  a raising of U.K. interest rates led to selling of British held assets in the U.S.. This is believed to have been connected to the stock market crash.

It's almost as though everything bad that could have happened did. The Federal Reserve Bank also increased interest rates prior to the stock market crash. This has the effect of restricting liquidity and raising the cost of capital, which in turn slows business activity. Business activity did slow and when the market began contracting, the excess of leveraged capital caused wide spread indebtedness and increased selling. It was the worst financial calamity in U.S. history.

Stock Market Crash Of 1929 from odontsetseg

The situation today is very different. Monetary policy is more elaborate and sophisticated. It also has the lessons of history to know what to avoid. For example, at the onset of the Great Recession, liquidity was increased via lowering interest rates. An unprecedented asset purchasing program also added financial stimulus to the economy. Federal tax credits such as the Making Work Pay tax credit also provided a way to redirect the U.S. economy to a growth trajectory. 

Despite central bank actions and a more mature and stable U.S. economy, the economic environment of today also presents new challenges per Forbes. For example,  although food price deflation is not a problem now, over-leveraging and excess liquidity do seem to have reached their upper limits of effectiveness. In fact, banks have been required to deleverage in order to prevent a second Great Recession from occurring. Prior to the recession there was an overabundance of speculative investing using leveraged positions. Greater regulation of the housing market in addition to banking practices followed thereafter in legislation such as the Wall Street Reform and Consumer Protection Act.

The U.S. economy is also unlikely to grow at a faster rate than 2-3% per year due to its large size. This is because the larger an economy becomes, the more national output is required to grow the economy by the same amount of percent as in previous years. In other words, growth becomes more difficult. The slow growth affects the job market, which in turn influences consumer spending. Since consumer spending is a large part of U.S. economics, a slowing or decline in expenditures negatively impacts GDP growth. Slow wage growth, which is also a problem now, aggravates the spending problem.

When economic growth slows, the stock market tends to respond negatively since corporate revenue forecasts and an increase in the probability of lower profit margins emerge. Cost cutting and low hiring are an additional effect of this. The high unemployment then creates political and economic pressure to increase government social and fiscal assistance. How economists and politicians react to the maturing U.S. economy will have a significant influence in the direction of U.S. economic growth and the direction of the stock market.