On the eve of the great 1929 stock exchange collapse, a journalist asked a speculator how so much money was being made on the market. This was the reply:
"One investor buys General Motors at $100"(he meant a GM share) "sells to another at $150, who sells it to a third at $200. Everyone makes money".
This seems pure magic, but for a while it can work. In a 'bull market' as in 1925-29 nearly all share prices go up and up. Over those years US industrial shares trebled in price!
It's happened again. In 1982 the Dow Jones index of American share prices hit 1,000. Now shares are yoyo-ing around at just under 11,000. For most of that period 'investors' could just sit back and watch their money grow by more than 15% a year.
At the end of 1928 outgoing President Coolidge surveyed the American economy with undisguised complacency. "No Congress of the US ever assembled" he intoned, "on surveying the state of the Union, has met with a more pleasing prospect than that which appears at the present time. In the domestic field there is tranquillity and contentment......and the highest record of years of prosperity".
Today, as in 1929, experts are wheeled out to assure us that 'the market is fundamentally sound'. But marxists believe that what goes up must come down.
To understand the apparently mysterious movements of the stock exchange, we must go back to basics. The foundation of the capitalist system is the pumping of surplus value (unpaid labour) from the working class in the production process. The capitalists own the means of production mainly in the form of shares. A share in a company is simply a piece of paper entitling its owner to a regular dividend. A share dividend is simply that part of the firm's profits that is paid out to the shareholders. That dividend in its turn can only be a part of the unpaid labour of the working class.
Once a company has been floated on the stock exchange, its shares pass from hand to hand. The company in question gets no part of the share's selling price. If I buy a second hand Ford share, Ford no more benefits than if I buy a second hand Ford car. Of course new shares can be issued to finance new investment. But since the Second World War this has been an insignificant source of investment finance, specially in the Anglo-Saxon countries. The main funds either come from funds ploughed back, or from bank loans. In fact in some years in this country share capital has been a negative source of company finance - firms have actually gone out spending money to buy back their own shares.
So shares are just pieces of coloured paper traded on the exchanges. How do speculators assess their value? One point of holding a share is to collect the dividend. So a share price reflects expected future profitability. But if profits are expected to rise, then the price of the piece of paper will rise as speculators pile into shares. So as the bubble blows itself up, speculators gain both ways - from dividends and the rising price of their paper asset. We get the interesting situation where shares are going up because people are buying them - and people are buying them because the share prices are going up.
The herd instinct of the traders can produce rushes and panics for all manner of reasons. At root though the health of the stock exchange is a reflection of the profitability of the real economy - even though there can be time lags and overshooting before trends in the real economy eventually make themselves felt on the floors of the exchanges.
Once a bull market has begun, the 'animal spirits' (as Keynes called them) of the entrepreneurs take over. Everyone wants to be in on the getting while the getting is good. An orgy of swindling is the natural result. This signals that the boom is peaking, and was regarded as a natural stage in the cycle in Kindelberger's classic book 'Manias, panics and crashes'. In the 1920s the Florida land boom pushed up the price of a plot of land from $1,500 in 1914 to $1.5 million in 1926 - even though the land in question was a patch of swamp! (That particular plot, following the inevitable and spectacular collapse in land prices, has still to this day not recovered its 1926 price.)
Collapsed
There have been speculative booms before and since. The capitalists who take part are not stupid. Their system is stupid. As the Chicago Tribune pointed out in 1890, "In the ruin of all collapsed booms is to be found the work of men who bought property at prices they knew perfectly well were fictitious, but who were willing to pay such prices simply because they knew that some greater fool could be depended on to take the property off their hands and leave them with a profit". Regular readers will recall that we have already got beyond that stage in the present cycle, as evidenced by the bailout of the crooks at Long-Term Capital Management, the mysterious but powerful hedge fund (see issue 64).
Just like the 1920s, the present period has produced in the likes of Calvin Coolidge the illusion that the good times will go on for ever. They are talking about a 'new paradigm' - a whole era of capitalist upswing in the offing. Older hands know that when that sort of talk starts it's time to sell. In September 1929 the Times (which was once a perceptive paper) commented, "It is a well-known characteristic of boom times that the idea of their old unpleasant way is rarely recognised as such". Samuel Brittan has written a couple of articles recently attacking the notion of a new paradigm in the Financial Times - 'Nonsense on stilts' and 'Bubbles do burst'. The economic analysis unit of the HSBC, formerly the Midland Bank, says "Virtually all the indicators checklist are flashing red for the US" and "When such bubbles burst soft landings never seem to be within reach". And what is the FT hinting at when in August they publish as part of their series on business classics Charles Mackay's 'Extraordinary popular delusions and the madness of crowds'?
Share manipulations and the urge to buy shoot way beyond the ability of the real economy to deliver more and more prosperity to the upper classes. As the share boom peaks the speculators look like a load of Hanna and Barbera lemmings who have just run over a cliff and are only held aloft by their own obliviousness to their real situation. But the laws of gravity will assert themselves. What goes up must come down. The crash brings them back to earth.
Going down
A secondary failure or hiccup can turn boom into bust when the time is right, as we shall see. Then we have another interesting situation where speculators sell shares because they are going down - and shares are going down because people are selling them. The whole film of the boom is played back in reverse.
Serious analysts have tried to explain the Wall Street crash as being caused by Massachusetts Department of Public Utilities forbidding Boston Edison which generated its electricity from 'watering' its shares by splitting them 4-1.Others have derived the Crash from the failure of the Clarence Hatry group, which made slot-machine vending devices, in Britain in September. If such an issue is capable of producing a devastating depression throughout the world, leading in time to the rise of Hitler and the Second World War, then there could be no greater indictment of the irrationality of capitalism. But of course this was a superficial glitch that could be shrugged off if the economy was in boom. Arguments between capitalists over the spoils are after all a permanent feature of capitalism. Rummaging through these explanations, Galbraith muses as to the crisis of confidence, "What first stirred these doubts we do not know, but neither is it very important that we know." The fact is that such incidents are at best triggers of crisis, but not its ultimate cause.
Then there is the theory that the crash was a manifestation of panic. Well, it was. Galbraith's book 'The great crash 1929' is mainly about Wall Street, not the real economy. He describes the mood on the exchanges on Thursday October 24th."That day 12,894,650 shares changed hands, many of them at prices which shattered the dreams and the hopes of those who had owned them....The panic did not last all day. It was a phenomenon of the morning hours....the uncertainty led more and more people to try to sell. Others, no longer able to respond to margin calls, were sold out. By eleven-thirty the market had surrendered to blind, relentless fear. This indeed was panic." But the panic, as we show, was rooted in the collapsing profits of the firms whose shares were being traded relentlessly down. Mass psychology is often used by people who can't explain events in any other way. But by explaining everything, they explain nothing. The events described by Galbraith are from the first nasty hiccup, before the meltdown of Black Tuesday October 29th. The exchanges had already been drifting down throughout September, and there had been a couple of panic attacks the previous year. Animal spirits and the herd instinct can explain why share prices soar above the objective possibilities of making money out of the working class. October 1929 showed they could also crash below. But these attitudes merely amplify the swings in an economy based on profit-making.
Another explanation offered for the crash was the phenomenon known as margin trading. In the 1920s it was common for speculators to buy by putting a small fraction of the face value down in hard cash , with the rest to follow. In a rising market, what was the harm? In three months time the share was bound to be worth more than what it was now. This sounds very arcane, but it's not much different from buying from the grocer on tick. It's credit - borrowing. To be more exact it's gambling with other people's money. It's the equivalent of borrowing from the bank to put money on a dog. So long as the dog wins there's no problem paying the bank back. But if it doesn't...
The difference with Wall Street in 1925-29 was that all the dogs were coming in. That's how it is on the stock exchange in a bull market. But just to make it interesting, all of a sudden all the dogs start to lose for no obvious reason. All shares go down in what is called a bear market. That is what happened in October 1929.
Catastrophic
The 'explanation' of margin trading doesn't explain the sudden reversal of trend. It helps to explain why the reversal was so catastrophic and became so general. It explains why brokers were found washed up in the Hudson river with a pocket of nothing but margin calls.
Margin trading was gambling with other people's money. What it did was drag wider layers of people into the rout. It spread the collapse on the stock exchange to the rest of the economy by making a lot of people a lot poorer very suddenly. But gambling with other people's money is a general feature of capitalist finance. It's called leverage in the trade. Long-term, the hedge fund that was bailed out after near collapse last year was doing just that. That is precisely how hedge funds make their money, and why it matters to the rest of us when they don't.
It would be a mistake to get dragged too deep into the 'explanations' offered by the wizards of high finance. "The difficulty with all these lines of reasoning, however, is the speed with which the collapse of production took place, and the fact that it began well before the stock market crash. Industrial production fell from 127 in June to 122 in September, 117 in October, 106 in November, and 99 in December. Specifically, automobile production declined from 660,000 units in March 1929 to 440,000 in August, 416,000 in September, 319,000 in October, 169,500 in November, and 92,500 in December.
Credit system
No quantity theory of money or autonomous shift in spending, with or without a decline in the stock market, can account for these precipitous movements. They require an old-fashioned theory of the instability of the credit system." This quote comes from Kindelberger's classic 'Manias, panics and crashes'. He is polemicising against the conventional monetarist and Keynesian explanations of the slump. One correction needs to be made to his last sentence. What we need is an old-fashioned theory of the instability of the capitalist system. And that starts with its profit-making potential. Looking at fundamentals, we see that industrial profits were up 156% between 1924 and 1929. But industrial shares trebled in value over the same period. By 1929 the system had exhausted its ability to keep pushing profits up, and the stock exchange was walking on air.
Kindelberger is right to raise the role of credit, but he doesn't see its wider social context. What newcomer to marxism has not sighed in irritation as they open Capital and find an apparently pointless discussion as to how in a commodity private labour presents itself as its opposite - social labour. But the point Marx is making is that there is a division of labour, but in a commodity, capitalist economy our mutual dependence goes unrecognised. In the 1920s there was a well-established worldwide division of labour, in which the USA produced most of the world's cars while Malaysia specialised in the export of tin and rubber. We need tin to make solder joints and for various other uses in car production. Any engineer can work out how much tin we need to make a car, and how much to make 660,000 cars (US production in March 1929). It's even easier to work out how much rubber goes in a tyre. But under capitalism nobody makes those calculations - that would be the way in a planned economy. Nobody knows how much tin or rubber or how many cars the world needs. In a global economy dominated by commodity production individual capitalists plough their lonely furrow, concerned only with the making of money.
But when the car factories started laying workers off, and by December 1929 were only churning out 92,000 cars, that was bad news for tin and rubber workers in Malaysia. The little local difficulty in Detroit became a global crash. That is what credit does - it generalises local problems as well as it generalises local prosperity. It drops us all in the same thing together, whether we know it or not. Credit is one of the ways we are all drawn into the world economy as cogs. It is one way a global division of labour is established behind the backs of the participants.
We have seen that the economist Thomas Wilson was right when he noted that the market slump "reflected in the main the change which was already apparent in the industrial situation". But the financial collapse in turn reacted back on the fundamentals. By 1929 one and a half million people had been drawn in to playing the stock market. It was these little people who were most likely to be suckered in the wake of Black Tuesday. Of course as the ordinary folk who had lost everything pulled their belts in so tight it almost cut them in half, then they certainly were going to have to stop running out every year and buying a new car. Very likely they might sell their existing model to get themselves out of a financial hole. This nice supply of cheap nearly-new cars, of course, was further cutting into the market for new cars, and the jobs of car workers. This further piece of bad news would be heard soon enough in Malaysia. The lesson of 1929 was - we're all in this together. The crisis began in the real economy, not on Wall Street. The crash made things worse back there in industrial USA, and all over the world where commodities are produced and exchanged.
The slump spiralled down, in production, trade and money. In 1932 there were 15 million jobless in the States, out of a labour force of 45 million. By the beginning of 1933 American national income had fallen by a third. World trade in this year was less than a third of its 1929 level. Germany was particularly hard hit by the Stock Exchange crash and the subsequent depression. If industrial production in 1929 is taken as 100, by 1932 it was only 53. That statistic, and the failure of the workers' leaders to respond, led straight to the rise of Hitler.
Banks go bust
Most people keep their money in banks. If too many lose their money, the banks go bust. Over this period about 9,000 banks closed their doors in the States. The banks tried to hang on by ruthlessly foreclosing on mortgages, bankrupting swathes of American farmers, especially in the south-western states. As the banks went bust, most people who kept their money in them lost everything. And so on.
In Austria in 1931 the Kredit Anstallt bank, laden with debt, bowed out. The ensuing wave of bankruptcies deepened the crisis throughout Europe.
In Britain the collapse of Kredit Anstallt brought a speculative attack on the pound. The Treasury demanded the minority Labour government of Ramsay MacDonald show its responsibility to the international financiers by cuts in public spending - cuts in benefit, teachers' wages and servicemen's pay. Today this would be called a Structural Adjustment Programme. The Labour government split, was ousted and replaced by a National Government, including Labour renegades, who came to power with a brief to put the boot in to working people. The political repercussions of the Crash, and the slump that followed it were huge. It changed the face of the planet.
To the question - 'will it happen again?' - the answer must be not whether, but when. The bad news from 1929 about bull markets is - the bigger they come, the harder they fall.