Crash of '29: where did all the money go?

Factual Questions
1

Not sure if this should be GD or GQ: moderator move if necessary.

The grade school explanation of the stock market crash of 1929 goes like this: people bought stock during the 1920s in the expectation that it’s value would go up and they could later sell it at a profit. This became a self-fullfilling prophecy- a “bubble”. This was aided by the fact that at the time people could buy stock on 10% margin- they only had to pay 10% of the price up front, and could owe the rest, which they could easily repay when they sold the stock at a profit. Both people and banks “invested” money in stocks that by the end of the decade were vastly inflated in price beyond anything that the issuing companies’ actual earnings would justify. Eventually, people got nervous and started selling stock in a self-accellerating “crash”. People who had invested all their savings in stock saw their value of their investment evaporate. Banks that had loaned money to buy stock or bought stock themselves had nothing but worthless paper as assets. When depositors went to get their money out of the bank, the bank had little actual cash to give them. This sparked “runs” on banks, similar to the stock panic. Banks went under when they had no assets left and those who had deposited money in the banks lost their savings. With the disappearence of vast sums of money, the economy was disrupted, businesses failed, people were out of work, and the Great Depression lasted ten years.

My question is, where did the money go? That is, how could vast sums of money simply cease to exist? In every transaction where stock was bought, it had to be payed for somehow; where did that payment go to? If Mr. Smith bought Acme Amalgamated stock at $10 dollars a share, and after the crash AA stock was worth 10 cents a share, what happened to the other $9.90 that Smith payed out? Did Acme themselves invest in other stock? But then what did the other company do with the money? Maybe a handfull of lucky bastards had the foresight to sell short at exactly the right time, but that doesn’t account for more than a tiny fraction of the wealth tied up in stock. Did the companies spend stock revenue on executive compensation? Invest in expansion that left them overequipped for the depressed demand of the 1930s? Was the money simply spent, and dispersed in the economic equivalent of entropy?

2

Deflation. Yesterday’s $500 is today’s $39.50. Money is an abstraction, you know.

3

I’d absolutely agree without questioning today, but back then the US was still using specie. So how does deflation work when the value of the dollar is pinned to a specific amount of metal?

4

A lot of that borrowed money never got paid back, and banks and whoever else lent cash to speculators took a huge hit.

5

Here’s the tricky part. The money was never there. Smith didn’t pay out the other $9.90. He borrowed it. “Margin” is just another word for “charge account.”

Here’s how the scenario worked. Smith buys stock worth $10 on margin. He only puts down $1, on the understanding that he’ll pay off the balance when he sells the stock.

The stock goes up to $20. Great. Smith buys more stock on margin. Remember, he’s only putting down 10% of the actual price in cash (actually, I think in those days you could open a margin account for only 5%.)

Then the stock crashes to 10 cents per share. The broker calls the margin payment (that was in the terms of the contract, which Smith didn’t read very closely.) It doesn’t matter what the stock is currently selling at, the contract was that Smith would pay $10 (or $20) for the stock, and the broker demands that Smith pay up.

But Smith was betting with money he didn’t have. The stock is now worth only 10 cents, but he still owes $9 for the first batch of stock, and $18 for the second batch. Smith is forced to use up his savings, sell his house and car for whatever he can get. If that still doesn’t cover everything, Smith goes bankrupt.

Smith can’t pay the broker. Therefore the broker can’t pay the investor who originally sold the stock to Smith (who wasn’t worried about getting HIS money as long as the stock prices kept rising. Once the stock crashed, he wasn’t interested in retrieving 10 cent stock. He wanted the $10 he agreed to sell the stock for.)

Since the broker guaranteed the sale, the broker is on the hook, as well as Smith. With Smith and the broker bankrupt, they can’t pay for their houses. The real estate market then goes belly up. They stops buying things. The retail market, then the wholesale market, then the manufacturers, then the raw material suppliers go bankrupt.

What about the guy who originally sold the stock to Smith for $10? He never got his money, so he goes bankrupt, as well.

Multiply this by a few million investors and you get the general drift.

I recommend you rent the Eddie Murphy-Dan Ackroyd movie Trading Places. Although it’s a comedy, it includes a surprisingly clear and thorough example of how the whole thing works.

6

The amazing thing is that while here were people that lost BIG, there were big winners as well. Not everyone was beggared on that day.

7

Think of it this way. You have a beautiful, valuable Ming Dynasty vase. It’s worth $50,000. It is equity for you. You break it. Where did the money go? It’s hard to tell. It had value, but now it doesn’t.

And worse, most of the stock purchase around that time was purchased on margin. They paid 10% of the value of the stock, hoping it would go up enough that when they sold it they could pay off their margin debt and still have some profit. They were betting it wouldn’t go down past their That would be like if you bought the vase for $5000 and the broke it, you would still owe $45000, but you wouldn’t have the vase.

This type of margining led to some very strict rules on buying on margin these day. Now you much have 50% to put down and maintain at least 40% of the value in your account. If you drop below that you much send money or sell the stock at a loss. But at least you don’t end up owing more than it’s worth. Most of the time. (I used to be a margins analyst, I could tell you horror stories.)

The companies these people purchased stock in went out of business or declined so much in value that their stock became worth much less than purchase price, or indeed, nothing at all. But people still had to pay the brokerage firms and bank the other 90% they borrowed to buy it in the first place.

Most of the wealth was on paper only. Just the way the wealth in the broken vase vanished, so did the riches of the stock market.

8

The fundamental mistake in the OP is that it assumes a law of conservation of wealth that just isn’t there. Wealth can be created and destroyed.

The other tricky part is that while the value of currency was tied to the gold standard, the value of stock never was. Stock has always been worth exactly what a buyer and seller will agree the price is.

9

While the answer to your question has been nicely answered by the intervening posters, not all money was based on specie(silver and gold) at that point. There were also Federal Reserve Notes circulating, which, like today’s currency, are only backed by the faith in the government.

10

No actual money was destroyed. The people who made out fine throigh the crash were speculators like Joseph Kennedy. he sold off all of his stocks months before the crash, and people like him 9who sold at the top) made out like bandits:
-they were flush with cash
-as the depression wore on 9and prices deflated0, people like Kennedy could buy up hard assets cheap-like the Chicago merchandise mart 9which the family trust unloaded a few years ago).
The people who got ot became the billionaires of the 40’s 50’s and 60’s.
incidentally, had you kept your stocks through the crash of 1929, it would have taken you almost 12 years to recoup the value you had lost. Which is OK if you were a Mellon or Carnegie-if you were an ordinary investor, you were SOL.

11

Cite?

:dubious: :dubious: :dubious: :dubious: :dubious:

'Cause I’ve never heard of anybody who was a “winner” in '29. :rolleyes:

12

Here.

13

When a company (like SDMBSE: ACME) needs to raise money, they issue stock. So for example, ACME issues 100,000 shares at $10 a share, they have raised $1,000,000. So ACME has $1M and there are 100,000 being traded back and forth on the market. So when Mr. Smith (no relation) buys his share, he isn’t giving the money to ACME, he is giving it to whoever held the stock at the time.

Now typically that $1M will be invested in growing the company and the price of the stock will theoretically rise to reflect the value of that growth. Now if the stock price exceeds the value it reflects, due to irrational exhuberance or mismanagement, there might be a correction in the price once people realize it.

Basically it becomes like a game of hot potato. Everything is fine as long as you aren’t the one holding the potato when the music stops.

14

Everyone knows about the bubble, but few people realize that stocks swung in the opposite direction, to being ridiculously under-valued, over the next four years. By 1933 people thought the world was going to hell in a hand-basket, and that the demise of capitalism was nigh, and stocks were close to worthless.

This was as much an over-reaction as the 1929 bubble. The economy did eventually recover, and people who bought during the 1933 trough made out like banshees.

[quote=samclem**There were also Federal Reserve Notes circulating, which, like today’s currency, are only backed by the faith in the government.[/quote]

Federal Reserve notes were redeemable in specie until 1933.

15

I didn’t realize that the Keening Spirits Heralding Death were such keen capitalists. Learn somethin’ every day.

16

My father, a barber, had a long time customer who was the cashier, and part owner of a local bank. In the 1932-33 depths of the depression corn fell to about 15 cents a bushel. By 1935 is was up to 50 cents after the establishment of the agricultural legislation. Under this legislation the government would by corn at some set price.

One day dad asked the banker why he hadn’t bought up some corn because it was virtually certain that corn wasn’t going to stay at 15 cents. The banker said, “You don’t understand a depression. That means you are depressed about the economic state. I had money to buy corn and still have money left over but I was damned if I was going to let go of any of it. After the bank holiday I wasn’t even sure I wanted to keep it in the bank.”

17

I’m sorry David Simmons, I don’t understand. Corn may have been 15 cents in 1933, and 50 cents in 1935, but that doesn’t mean that corn (being perishable) would be a good investment in 1933, would it?

I’ve made all my money in cardboard. I bought it when it was 14 cents a ton. And you know what it is now - 16 cents! And I bought three tons of it, so that’s… well, you can figure it out. I got a special deal with my broker so that I only had to keep two tons of it at my house.

(stolen directly from Steve Martin)

18

Corn and other agricultural commodities like that, are bought and sold on the futures market. Lets say corn is selling for 15 cents a bushel now. So the buyer enters into a contract with the farmer that basically says (I’m oversimplifying here), “I guarantee I’ll buy x bushels of corn from you at 15 cents a bushel on x date”. Now that I have that contract, I can hold on to it, or sell it to someone else, or whatever. But whenever that contract comes due, whoever owns it has to pay the farmer 15 cents a bushel for whatever amount the contract is for, and, in exchange, he gets the corn (which he can then sell on the market for the spot price).

19

So, the stock market is a zero-sum game-for everyone that loses, somebody wins. I would say that the people who were wiped in in 1929 were small investors and speculators. The big money people who could wait out the depression made out fine…by 1939, the US economy was staring to move (war contracts from europe and the US). Granted, 1929-1939 is a long time, but if you are rich, who cares?

20

The OP assumes that wealth is a bigger slice of a finite pie. It isn’t. You don’t always create wealth by acquiring more of the one trillion existing marbles. You can also take seven cents’ worth of raw ingredients and combine it in a way that you can resell for five dollars (SEE: Starbucks coffee, Coca-Cola at your movie theater, any work of art, etc.) In 1929, after the crash, people were less inclined/able to buy the marked-up recombinant.