Stock Market Crashes and Financial Cycles: Part I
"The very existence of the Federal Reserve System is a
safeguard against anything like a calamity growing out
of money rates...In former days the psychology was
different, because the facts of the banking situation
were different. Mob panic, and consequently mob
disaster is less likely to arise." - Benjamin Strong, head
of the Federal Reserve Board, a few days before the
1929 stock market crash
"I believe we have successfully repealed the business
cycle" - Robert Rubin, Secretary of the Treasury, days
before the Asian financial meltdown of October, 1998.
In the Spring of 1929 a young English tennis player,
William Wentworth, took a New York to London trip
on a small ocean vessel. With no airplanes back in those
days, the only way to travel from overseas was on the
sea itself. On the boat's deck, Wentworth and a few of
his tennis buddies struck up a conversation with a man
calling himself Mr. Skinner.
Skinner wore a long black cloak and large broad
brimmed hat. One of Wentworth's friends recognized
him as Montagu Norman, the head of the Bank of
England. The tennis boys told him that they knew who
he really was, but Norman didn't care. However, he told
them not to blow his cover, because if the details of his
movements were made public they could have serious
financial consequences. The kids agreed and the group
met periodically for breakfast and lunch as the voyage
continued.
Norman took a liking to Wentworth and one day he
took him aside. "In the next few months there is going
to be a shake-out" in the stock market, he warned him.
When Wentworth got home he sold off his stocks and
mutual funds. A few weeks later, on August the 9th the
Federal Reserve Board met in New York City and
raised interest rates. The Bank of England followed.
The rate on margins loans jumped 5 percentage points.
The stage became set for a financial calamity.
Wentworth, thanks to advance knowledge, knew to get
out beforehand.
He wasn't the only one. Months ago, in March, 1929,
Paul Warburg, one of the architects of the Federal
Reserve and one of the largest bankers in the world,
warned his friends in a letter that "if the orgies of
unrestrained speculation are permitted to spread, the
ultimate collapse is certain not only to affect the
speculators themselves, but to bring about a general
depression involving the entire country." Warburg was
a member of the Wall Street firm Kuhn, Loeb, and
Company, which maintained a list of customers who
included some of the wealthiest men in the world. The
firm warned them about a coming market crash. They
included John D. Rockefeller, Joseph P. Kennedy,
Bernard Baruch, Henry Morgenthau, and Douglas
Dillon. All sold out before the stock market crash and
Baruch and Kennedy made fortunes going short.
>From 1921 to September of 1929 the DOW Jones
industrial average rose 597%. Heads of the world's
largest banks and the Federal Reserve board believed
that there was an orgy of speculation that was getting
out of hand. They feared that if the stock market
continued to rise than inflation would appear. The
Secretary of the Treasury, Andrew Mellon, agreed. As
President Herbert Hoover described it: "Mr Mellon had
only one formula: liquidate labor, liquidate stocks,
liquidate the farmers, liquidate real estate. He insisted
that when the people get an inflation brainstorm, the
only way to get it out of their blood is to let it collapse.
He held that even a panic was not altogether a bad
thing. He said: 'It will purge the rottenness out of the
system. High costs of living and high living will come
down. People will work harder, live a moral life. Values
will be adjusted, and enterprising people will pick up
the wrecks from less competent people.'"
Some people knew that the stock market was going to
crash. The same was true before the April 2000 crash. A
book released in the fall of 1999 reported that Alan
Greenspan had told people that he did not think a stock
market crash would harm the economy. In the Fall of
1999 I read a white paper by the International
Monetary Fund that stated that a US stock market
crash poised the largest risk to the world economy and
would likely happen in 2000. Around the same time
Barron's magazine reported that some of the largest
market traders, including Carl Ichan, were preparing to
heavily short the market. They were off by months, but
the general consensus that stock market turmoil lay in
the future could be heard in the air.
Interest rate hikes by the Federal Reserve Board
triggered both stock market crashes. However, the times
are not the same and the effects have not been the same.
This is not 1929. But there is a lot to be learned from
the 1929 crash. In part II. I'll begin an examination of
the business cycle and several large scale economic shifts
that have taken place in history. The 1929 crash came at
the end of one of these shifts. We are undergoing
another large scale economic shift which will have long
term repercussions right now. The recent stock market
bubble and subsequent crash is a part of that. |
