What Happens to Gold When the Stock Market Crashes
The Roaring Twenties roared loudest and longest on the New York Stock Exchange. Share prices rose to unprecedented heights. The Dow Jones Industrial Average increased vi-fold from sixty-three in August 1921 to 381 in September 1929. After prices peaked, economist Irving Fisher proclaimed, "stock prices take reached 'what looks like a permanently high plateau.'"1
The ballsy smash ended in a cataclysmic bust. On Black Monday, October 28, 1929, the Dow declined nigh 13 percent. On the following solar day, Black Tuesday, the market dropped virtually 12 percent. By mid-November, the Dow had lost almost half of its value. The slide continued through the summer of 1932, when the Dow closed at 41.22, its lowest value of the twentieth century, 89 percentage below its peak. The Dow did not return to its pre-crash heights until Nov 1954.
The financial boom occurred during an era of optimism. Families prospered. Automobiles, telephones, and other new technologies proliferated. Ordinary men and women invested growing sums in stocks and bonds. A new manufacture of brokerage houses, investment trusts, and margin accounts enabled ordinary people to purchase corporate equities with borrowed funds. Purchasers put downwardly a fraction of the price, typically x percent, and borrowed the rest. The stocks that they bought served as collateral for the loan. Borrowed money poured into equity markets, and stock prices soared.
Skeptics existed, even so. Amid them was the Federal Reserve. The governors of many Federal Reserve Banks and a bulk of the Federal Reserve Lath believed stock-market speculation diverted resource from productive uses, like commerce and manufacture. The Lath asserted that the "Federal Reserve Human action does not … contemplate the use of the resources of the Federal Reserve Banks for the creation or extension of speculative credit" (Chandler 1971, 56).ii
The Board's opinion stemmed from the text of the act. Section xiii authorized reserve banks to accept every bit collateral for discount loans assets that financed agronomical, commercial, and industrial action just prohibited them from accepting every bit collateral "notes, drafts, or bills covering only investments or issued or drawn for the purpose of carrying or trading in stocks, bonds or other investment securities, except bonds and notes of the Authorities of the The states" (Federal Reserve Human activity 1913).
Section 14 of the act extended those powers and prohibitions to purchases in the open market.3
These provisions reflected the theory of existent bills, which had many adherents among the authors of the Federal Reserve Act in 1913 and leaders of the Federal Reserve System in 1929. This theory indicated that the cardinal depository financial institution should issue money when product and commerce expanded, and contract the supply of currency and credit when economic activity contracted.
The Federal Reserve decided to deed. The question was how. The Federal Reserve Board and the leaders of the reserve banks debated this question. To rein in the tide of call loans, which fueled the financial euphoria, the Board favored a policy of straight activity. The Lath asked reserve banks to deny requests for credit from member banks that loaned funds to stock speculators.4The Board too warned the public of the dangers of speculation.
The governor of the Federal Reserve Depository financial institution of New York, George Harrison, favored a dissimilar approach. He wanted to raise the disbelieve lending charge per unit. This activity would straight increase the rate that banks paid to infringe funds from the Federal Reserve and indirectly raise rates paid by all borrowers, including firms and consumers. In 1929, New York repeatedly requested to raise its discount rate; the Board denied several of the requests. In August the Board finally acquiesced to New York's plan of action, and New York'south disbelieve rate reached 6 per centum.v
The Federal Reserve's rate increase had unintended consequences. Because of the international aureate standard, the Fed's actions forced foreign central banks to enhance their own interest rates. Tight-money policies tipped economies around the globe into recession. International commerce contracted, and the international economy slowed (Eichengreen 1992; Friedman and Schwartz 1963; Temin 1993).
The financial blast, however, continued. The Federal Reserve watched anxiously. Commercial banks connected to loan coin to speculators, and other lenders invested increasing sums in loans to brokers. In September 1929, stock prices gyrated, with sudden declines and rapid recoveries. Some financial leaders continued to encourage investors to buy equities, including Charles E. Mitchell, the president of the National City Bank (at present Citibank) and a manager of the Federal Reserve Banking concern of New York.6In Oct, Mitchell and a coalition of bankers attempted to restore confidence by publicly purchasing blocks of shares at high prices. The effort failed. Investors began selling madly. Share prices plummeted.
Funds that fled the stock market flowed into New York Metropolis's commercial banks. These banks too assumed millions of dollars in stock-marketplace loans. The sudden surges strained banks. As deposits increased, banks' reserve requirements rose; just banks' reserves cruel as depositors withdrew greenbacks, banks purchased loans, and checks (the principal method of depositing funds) cleared slowly. The counterpoised flows left many banks temporarily short of reserves.
To salvage the strain, the New York Fed sprang into action. It purchased government securities on the open up market, expedited lending through its discount window, and lowered the discount charge per unit. It assured commercial banks that it would supply the reserves they needed. These deportment increased total reserves in the cyberbanking arrangement, relaxed the reserve constraint faced by banks in New York Urban center, and enabled fiscal institutions to remain open for business and satisfy their customers' demands during the crisis. The deportment likewise kept short term involvement rates from rising to disruptive levels, which frequently occurred during financial crises.
At the time, the New York Fed's deportment were controversial. The Board and several reserve banks complained that New York exceeded its authority. In hindsight, yet, these deportment helped to contain the crisis in the short run. The stock marketplace collapsed, only commercial banks near the center of the storm remained in operation (Friedman and Schwartz 1963).
While New York'southward deportment protected commercial banks, the stock-market place crash still harmed commerce and manufacturing. The crash frightened investors and consumers. Men and women lost their life savings, feared for their jobs, and worried whether they could pay their bills. Fear and uncertainty reduced purchases of big ticket items, like automobiles, that people bought with credit. Firms – like Ford Motors – saw demand decline, so they slowed product and furloughed workers. Unemployment rose, and the wrinkle that had begun in the summer of 1929 deepened (Romer 1990; Calomiris 1993).7
While the crash of 1929 concise economic action, its impact faded within a few months, and by the autumn of 1930 economical recovery appeared imminent. Then, problems in another portion of the financial system turned what may have been a brusque, abrupt recession into our nation's longest, deepest depression.
From the stock market crash of 1929, economists – including the leaders of the Federal Reserve – learned at least 2 lessons.eight
Start, cardinal banks – like the Federal Reserve – should be careful when acting in response to disinterestedness markets. Detecting and deflating financial bubbles is difficult. Using monetary policy to restrain investors' exuberance may have broad, unintended, and undesirable consequences.9
Second, when stock market crashes occur, their damage tin can be contained by post-obit the playbook developed by the Federal Reserve Bank of New York in the fall of 1929.
Economists and historians debated these issues during the decades following the Not bad Depression. Consensus coalesced around the time of the publication of Milton Friedman and Anna Schwartz's A Monetary History of the United States in 1963. Their conclusions apropos these events are cited by many economists, including members of the Federal Reserve Board of Governors such as Ben Bernanke, Donald Kohn and Frederic Mishkin.
In reaction to the fiscal crisis of 2008 scholars may be rethinking these conclusions. Economists take been questioning whether central banks can and should prevent asset market bubbles and how concerns about financial stability should influence budgetary policy. These widespread discussions hearken back to the debates on this upshot among the leaders of the Federal Reserve during the 1920s.
Bibliography
Bernanke, Ben, "Asset Price 'Bubbles' and Monetary Policy." Remarks before the New York Chapter of the National Association for Business organisation Economics, New York, NY, October 15, 2002.
Calomiris, Charles W. "Financial Factors in the Great Low." The Journal of Economic Perspectives 7, no. 2 (Spring 1993): 61-85.
Chandler, Lester V. American Monetary Policy, 1928-1941. New York: Harper and Row, 1971.
Eichengreen, Barry. Gold Fetters: The Gold Standard and the Slap-up Depression, 1919 –1929. Oxford: Oxford University Press, 1992.
Federal Reserve Act, 1913. Pub. 50. 63-43, ch. half dozen, 38 Stat. 251 (1913).
Friedman, Milton and Anna Schwartz. A Monetary History of the United States. Princeton: Princeton University Press, 1963.
Galbraith, John Kenneth. The Great Crash of 1929. New York: Houghton Mifflin, 1954.
Greenspan, Alan, "The Challenge of Key Banking in a Autonomous Society," Remarks at the Annual Dinner and Francis Boyer Lecture of The American Enterprise Found for Public Policy Research, Washington, DC, December 5, 1996.
Klein, Maury. "The Stock Market place Crash of 1929: A Review Article." Business History Review 75, no. 2 (Summertime 2001): 325-351.
Kohn, Donald, "Monetary policy and nugget prices," Speech at "Monetary Policy: A Journey from Theory to Practice," a European Central Bank Colloquium held in honor of Otmar Issing, Frankfurt, Federal republic of germany, March 16, 2006.
Meltzer, Allan. A History of the Federal Reserve, Volume one, 1913-1951. Chicago: University of Chicago Press, 2003.
Mishkin, Frederic, "How Should We Reply to Asset Cost Bubbles?" Comments at the Wharton Financial Institutions Centre and Oliver Wyman Institute's Annual Fiscal Risk Roundtable, Philadelphia, PA, May 15, 2008.
Romer, Christina. "The Not bad Crash and the Onset of the Bully Depression." Quarterly Journal of Economics 105, no. 3 (August 1990): 597-624.
Temin, Peter. "Manual of the Cracking Depression." Periodical of Economic Perspectives seven, no. two (Spring 1993): 87-102.
Source: https://www.federalreservehistory.org/essays/stock-market-crash-of-1929