In the 1920s, the US economy enjoyed a long period of rapid growth and high employment. This was partly down to technological innovation and migration from rural to urban areas. But it was also driven by the wide availability of credit.
By the late 1920s, stock prices were soaring, leading more and more people to pile into the market. Many had bought shares ‘on margin’ – using only a fraction of the price as a down payment.
While the Federal Reserve warned that speculation was getting out of hand, it still injected money into the market to halt a drop in share prices during the spring, creating moral hazard.
Storm clouds began to gather in the wider economy. Even as economic indicators started to point to recession, protectionist forces began pushing a plan to raise tariffs greatly. Investors started to panic about the possibility of a trade war.
Eventually, on 24 October 1929 – ‘Black Thursday’ – confidence snapped, leading to The Wall Street Crash. The Dow Jones Industrial Average fell 11%. Leading bankers tried to calm things by pooling their resources to buy up shares. But prices had fallen so hard that those who bought shares on credit were forced to sell, flooding the market and driving prices even lower.
While the initial rout ended in November, the knock-on impact was huge – people lost faith in the financial system and began to pull their money from banks.
The passage of the protectionist Smoot-Hawley Act in 1930 and the Fed’s failure to stop the money supply from collapsing only made things worse. By the time the market finally hit rock bottom in the summer of 1932, it had fallen by nearly 90% from the high.