23:31 PM

The Second Financial Shock Could be Worse Than The First

I've been remarking lately that we haven't yet had the second market correction. People forget that after the stock market crash of 1929 the market seemed well on its way to a recovery before crashing a second time in 1932. It then took decades to recover. Investors would have to wait until November 1954 to recover to 1929 levels.

It won't be pleasant but we need that second correction so that we can get to work on the longer cycle of rebuilding value. With the current recovery in stock markets and some housing markets it seems that we might be building up to that second correction.

Is there anything that can be done to prepare? Fed Chairman Ben Bernanke is a student of the great crash so he would know best and be best positioned to mitigate its effects. But maybe there isn't much to be done except to let the financial system work through its destiny.

I was glad to see a post by DK Matai, chairman and founder of mi2g.net and ACTA Open writing about this topic on Facebook and he has some very interesting data. I'm republishing because ACTA Open is a closed group but I think this is an important article.


1932: The Unexpected Second Shock

By DK Matai

They will say, nobody saw it coming. Who could have predicted it... It is worth noting that the 1932 stock market crash is deemed to be the worst in the 20th century and not the one in 1929. By mid-1930, the market was up 30% from the trough of the 1929 crash. However, by the summer of 1932, the Dow reached a low of just 11% of its high in 1929, or a loss of roughly 89%, trading more than 50% below the low it had reached on October 29th, 1929. If one had $1000 on September 3rd 1929, it would have gone down to $108 by July 8th, 1932 -- end of the worst crash -- or an 89.2% loss. To recover from such a loss, one would have to watch one's portfolio go up by 825%!

All this happened despite assurances from prominent government and business leaders of-the-time that the worst was behind.

Here is a news headline that may sound familiar:

. September 1929: "There is no cause to worry. The high tide of prosperity will continue." - Andrew W Mellon, US Secretary of the Treasury

After the stock market crash in October 1929, the Dow Jones Industrial Average (DJIA) partially recovered in November-December 1929 and early 1930.

Reassuring headlines such as the following became increasingly common:

. May 1, 1930: "I am convinced we have now passed the worst and with continued unity of effort we shall rapidly recover. There is one certainty of the future of a people of the resources, intelligence and character of the people of the United States - that is, prosperity!" - US President Hoover

. August 29, 1930: "American labour may now look to the future with confidence." - James J Davis, US Secretary of Labour

. October 16, 1930: "Looking to the future I see in the further acceleration of science continuous jobs for our workers. Science will cure unemployment." - Charles M Schwab.

On July 8th, 1932 the Dow reached its lowest level of the 20th century and did not return to pre-1929 levels until 23rd November, 1954. The full impact was not felt until the next year. By 1933, the Great Depression was very real and it would take more than 22 years before the market would regain what had been lost.

So severe was the impact of the 1929-1932 crash, that by spring of 1933, when President Roosevelt (FDR) took the oath of office, unemployment in the US had risen from 8 to 15 million -- roughly 1/3rd of the non-farm workforce -- and the GDP had decreased by more than 45% from $103.8 billion to $55.7 billion. Although the depression was worldwide, no other country except Germany reached so high a percentage of unemployment as the US. The poor were hit the hardest. By 1932, New York's Harlem district had an unemployment rate of 50% and property owned or managed by African Americans fell from 30% to 5% in 1935. Farmers in the Midwest were doubly hit by economic downturns and the Dust Bowl. Schools, with budgets shrinking, shortened both the school day and the school year. The breadth and depth of the crisis made it the Great Depression.

FDR, after assuming the presidency, promoted a wide variety of federally funded programs aimed at restoring the American economy, helping relieve the suffering of the unemployed, and reforming the system so that such a severe crisis could never happen again. After the crash in 1932:

1. The Securities and Exchange Commission (SEC) was established;

2. The US Congress passed the Glass-Steagall Act mandating a separation between commercial banks, which take deposits and extend loans, and investment banks, which underwrite, issue, and distribute stocks, bonds and other securities;

3. The Federal Deposit Insurance Corporation (FDIC) was established to insure individual bank accounts for up to $100,000; and

4. Works Projects Administration (WPA), the largest New Deal agency, was set up employing millions to carry out public works projects.

However, while FDR's New Deal did help restore the GDP to its 1929 level and did introduce basic banking and welfare reforms, FDR refused to run up the government deficits that ending the depression required. Only when the federal government imposed rationing, recruited 6 million defence workers (including women and African Americans), drafted 6 million soldiers, and ran massive deficits to fight World War II did the Great Depression finally end.

The extent of the economic devastation of the 1930s went far beyond the imagination of anyone in the financial markets or governments across the world.


We welcome your thoughts, observations and views. To reflect further on this subject and others, please respond within Twitter,Facebook and LinkedIn's ATCA Open and related discussion platform of HQR. Should you wish to connect directly with real time Twitter feeds, please click as appropriate:

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Please see additional DK Matai posts:

The Size of Derivatives Bubble = $190K Per Person on Planet

Must Read Analysis: Why Markets Are Still Falling . . . The Shadow
Financial Systems

Beyond The Sub-Prime Bubble: The Other Seven Deadly Bubbles . . . - SVW