Wednesday, November 16, 2011

What was the main cause of the 1929 Stock Market Crash? Ans: The shortening of the work week and a belief that consuming luxuries leads to growth

I've taken a look at the economic data from the mid to late 1920's (such as the prices of oil, coal, steel, wheat, etc...) in order to try to understand what was the cause of the stock market bubble that started in ~1927 and ended in 1929. From just analyzing the price data of individual materials, it's hard to see anything that stands out (i.e. no oil sharp increases in the price of oil or steel.) But when you look at the overall trends, you see a disturbing trend toward purchasing more and more items for personal pleasure, thinking that these items were helping to grow the economy. In other words, it appears that people in the US on average were consuming more and more luxuries while working less hours per week (all the while without the increase in productivity that could have justified the increased spending on luxuries and reduced hours.) And what's worse is that people convinced themselves that consuming luxuries was sustainable, i.e. we could afford to let people work less hours and pay them more because they will purchase more goods and hence get the economy going. This turned out to be a disastrous mindset, and a mindset very reminiscent of what happened in the 2000's. In the last decade, we convinced ourselves that a) a house is an asset that should increase in value with time [as opposed to a car or almost any other item] and b) our economy can grow even if the price of oil triples in a few years.

What I'm interested in is the answer to the following question: what allowed people (who were supposedly raised on the hard work ethic of Benjamin Franklin and others) to think that an economy can grow by just consuming more and more luxuries?

This post is devoted to looking into what were the main causes of the stock market bubble that burst in 1929. The goal of the post is to look at what did and what didn't cause the bubble and its eventual crash.

First, by looking at the price of oil during the 1920's, one sees that the general trend was a decrease in the price of oil, so we can't blame high oil prices for the stock market crash. Likewise, the price of both bituminous and anthracite coal was relatively flat throughout the 1920's.
So, what was going on?

a) Lack of Innovation
It appears that there was a lack of new technologies being introduced in the decade between 1925 and 1935 (the worse decade in the twentieth century as far as new production innovation.)

b) A Shorter Work Week
Many companies were allowing employees to have shorter work weeks. The typical work week decreased from 6 days per week down to 5 days per week.

c) Tax Cuts
The top tax rate was lowered to 25% in 1925, allowing wealthy people to spend more money on luxuries.

d) Gospel of Consumption
Businesses started embracing and advertising for a new economic gospel of consuming luxuries. Businessmen thought that demand for luxuries could be stimulated, and that this consumption would lead to more consumption and hence to growth.

e) Leisure was deemed valuable in of itself
Some businessman were pushing for decreased work hours for workers so that they would have the time to consume more items during their "leisure" time. Some businessman thought the increased leisure time could actually promote economic growth

f) Labor Unions saw Less Work Hours as a Positive Means to Redistribute Wealth
Labor unions were pushing for and were obtaining decreased weekly work hours and increased hourly wages. But it wasn't just the labor leaders that were pushing for less work hours; it was also radicals, educators, religious leaders, sociologists, and psychologists who were pushing for shorter work hours. Higher wages and lower working hours were seen as a basic tenet of the social reform required to "improve capitalism without destroying it."

g) Reduced Work Hours rather than Increased Work Hours
Once the stock market crashed in 1929, many businesses (for example Kellogg cereal factories) decided to reduce the number of hours that an employee had to work rather than increased hours that had to be worked (which would have led to increased work productivity and probably would have led to increased growth.) Instead, businesses like Kellogg decided to hire a third set of factory workers, which increased the cost of the cereal, and in some small part, this made the Depression even worse. Somehow managers and the media convinced themselves (with the help of the labor unions) that shorter work hours was the cure for overproduction of luxuries and growing unemployment.

h) Demand for luxuries could be stimulated by advertising
The some businessmen believed that the growth of luxuries could be sustained via the use of advertising, forgetting that spending money on luxuries is a waste of exergy and a waste of generated work, and therefore, there is a negative rate of return on work invested. Spending money on luxuries is always limited by the amount of mechanical and electrical work available to produce the goods. If we spend money on consuming luxuries, then that's money that's not being re-invested into growing the number of power plants. There must be a balance between re-investing money into growing the number of power plants and allowing people to spend money on luxuries.

But it should be noted that there were people in the 1920s who foresaw that problems would occur by consuming more luxuries and working less hours. For example, John E. Edgerton, president of the National Association of Manufacturers, declared:

 “It is time for America to awake from its dream that an eternal holiday is a natural fruit of material prosperity, and to reaffirm its devotion to those principles and laws of life to the conformity with which we owe all of our national greatness. I am for everything that will make work happier but against everything that will further subordinate its importance in the program of life.”

Likewise George L. Markland had warned that "the men of our country are becoming a race of softies and mollycoddles . . .". He saw the five day week as an indication of "a gradual sinking into decay," a trend toward the dissipation and frivolity that had caused Rome's downfall."  (Quote references can be found at this link.)

So, I've listed eight of the problems that lead to the stock market bubble and burst in the late 1929. When added together, we see that there was not an actual problem in the amount of natural resources or labor available to grow American society. When added together, we see that the problem of the late 1920s was philosophical: the disastrous idea that consuming luxuries was not only sustainable, but that consuming luxuries would lead to grow of the economy.

I'm all for spending money on luxuries (if you're earned the money through hard work in a business with a positive rate of return on investment), but we need to have a mechanism in place to make sure that the consumption of luxuries does not consume all of the work we generate from our power plants. We need to be reinvesting some of the work we generate back into building more power plants. This is what I call "balanced growth." There is a balance between consuming luxuries and re-investment into building more power plants. In a recent article, I discuss the two main mechanisms for maintaining "balanced growth," which are 1) maintaining a work (i.e. electricity) backed currency, and 2) an adjustable tax on luxuries depending on whether the economy is growing or shrinking (i.e. the tax increases when the economy is as to force us to spend less on luxuries and re-invest more into power plants that generate a positive rate of return on investment...and this tax decreases when the economy is an incentive for the hard work it took to grow the economy.)

To avoid a repeat of the stock market crash of 1929 or 2008, we need to figure out how to achieve balanced growth. Today, that means either working harder/smarter or consuming less luxuries so that we have more work (i.e. electricity and mechanical work) available to re-investment into building new power plants.

While it might seem like I'm taking a complex subject (like the Cause of the 1929 or 2008 stock market crash) and boiling it down into too simple a cause, I'd like to conclude by pointing out the cause of the demise of most large civilizations has been either philosophical (such as the demise of the Roman Empire because of the growth of Christianity) or environmental (such as the collapse of Egyptian culture whenever the Nile stopped flooding for decades at a time.) In the case of 1929 stock market collapse, the cause was not environmental and was not limited resouces...the cause of the bubble and collapse was philosophical. Enough people started to believe that consuming luxuries items was sustainable, which explains both the bubble and the eventual burst. In other words, the philosophy of life that you hold has real world consequences.


Post Note: If you've read a fair number of my articles, you can probably guess that what got us out of the Depression was not government spending during WWII, per se. What got us eventually out of the Depression was the technological revolution unleashed by WWII in the areas of communications, power plant design, motor vehicle design, improved gas and steam turbines as well as advanced aircraft designs. While the technologies were not designed with the idea of obtaining a positive rate of return on work invested, many of the technologies developed during WWII led to technologies with a positive rate of return on work invested (especially gas turbines) and allowed us to grow our way out of the slump that was generated in 1930s by a culture of spending on luxuries.

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