Jin Haeng Lee
These days, everyone seems to be interested in the stock market; everyone
thinks he or she can make a huge fortune by participating in the stock market.
However, all the people should keep in mind that even Newton, the renowned
physicist who mastered mathematics, failed at predicting the stock market. This
shows that it is extremely difficult to foresee what is going to happen in the stock
market unless one tries to approach it with extreme carefulness.
One of the most efficient ways would be approaching it in a social studies
context; looking at the social events or issues that hugely impacted the stock market
would definitely help people to predict the future of the stock market. This essay
will discuss how the stock market has changed so far – the history of the stock
market. Moreover, the essay will explicate the current issues that possibly could
influence the stock market.
To begin with, in my opinion, to understand how the Dow Jones Indicator
works, people need to know what it is. The Dow Jones is the value of thirty main
companies in the United States combined. The following is the 30 companies that
consist of the Dow Jones Average.
Company
3M
Alcoa
American Express
AT&T
Bank of America
Boeing
Caterpillar
Chevron Corporation
Cisco System
Date Added
1976-08-09 (as Minnesota Mining and
Manufacturing)
1959-06-01 (as Aluminum Company of America)
1982-08-30
1999-11-01 (as SBC Communications)
2008-02-19
1987-03-12
1991-05-06
2008-02-19
2009-06-08
Coca-Cola
DuPont
ExxonMobil
General Electric
Hewlett-Packard
The Home Depot
Intel
IBM
Johnson & Johnson
JPMorgan Chase
Kraft Foods
McDonald's
Merck
Microsoft
Pfizer
Procter & Gamble
Travelers
United Technologies Corporation
Verizon Communications
Wal-Mart
Walt Disney
1987-03-12
1935-11-20 (also 1924-01-22 to 1925-08-31)
1928-10-01 (as Standard Oil)
1907-11-07
1997-03-17
1999-11-01
1999-11-01
1979-06-29
1997-03-17
1991-05-06 (as J.P. Morgan & Company)
2008-09-22
1985-10-30
1979-06-29
1999-11-01
2004-04-08
1932-05-26
2009-06-08
1939-03-14 (as United Aircraft)
2004-04-08
1997-03-17
1991-05-06
(The New York Job Source).
The chart above shows that most of the industries are included in the Dow
Jones Indicator after 1970s. Then one must be curious about what other industries
from 1896, when Dow Jones founded the Dow Jones Indicator, were included in the
consideration. There are thirty industries included in the Dow Jones Average these
days, at the beginning of its history, there were only 12 major industries that
comprised Dow Jones Average; other than General Electric, the other 11 industries
are now gone. The other industries are as follows; American Cotton Oil Company;
American Sugar Company; American Tobacco Company; Chicago Gas Company;
Distilling & Cattle Feeding Company; Laclede Gas Company; National Lead
Company; North American Company; Tennessee Coal, Iron and Railroad Company;
the U.S. Leather Company; United States Rubber Company (Money Zone). The main
reason that there were several changes in the list is that as the US economy has
grown to rely on other sectors, greater emphasis has been placed on companies
providing financial services, retailing, and technology (Geisst).
Now since I briefly discussed what consists of the Dow Jones Average, I will
mainly discuss the history of the Wall Street, which is the main center of stock
market of the world, and how Dow Jones Average has been changed. First of all,
although the original the Wall Street was created in the 17th century, the Wall Street
we know today was not created until the late 18th century. Stock-interested traders
gathered informally under a buttonwood tree around the Wall Street. Then in 1792,
the traders declared ‘Buttonwood Agreement’, which noted the beginning of the
New York Stock Exchange, or the Wall Street that people usually think of (The
Library of Congress). The significance of the Wall Street was evident even before the
Buttonwood Agreement. George Washington took the oath of office on the balcony
of Federal Hall overlooking The Wall Street on April 30, 1789 (GeisstCharles).
However, it was not until the late 19th century that The Wall Street became
the most important economical center of the U.S. As I mentioned above, in 1896,
Dow Jones Industrial Average was founded. As soon as it was founded, however, it
faced an immediate downfall, because of the Panic of 1893, followed by Panic of
1896; The Dow Jones Average falls from 40.94 to 28.48. Both Panics were marked
by the collapse of railroad overbuilding and shaky railroad financing which set off a
series of bank failures. Compounding market overbuilding and a railroad bubble
was a run on the gold supply and a policy of using both gold and silver metals as a
peg for the US Dollar value. The panics are considered the most serious economic
downfall until the 1920s, when the Great Depression hit the US (The history box).
Then again, in the 1900’s, the Dow Jones Average encounters another minor
downfall, due to the Panic of 1901 and 1907. The Panic of 1901 is important, as it is
the first stock market crash on the New York Stock Exchange. (note that it is not the
first crash on the Dow Jones Average; Dow Jones Average, as I mentioned, already
faced a downfall from the Panic of 1896)
Meanwhile, the Panic of 1907 was also known as 1907 Bankers' Panic, and
was a financial crisis that occurred in the United States when the New York Stock
Exchange fell close to 50% from its peak the previous year (Robert F.). The graph
following will show how the Dow Jones Average fell during 1907
(Henry).
The economic condition of US before the panic of 1907 was not pleasant. In
addition to the panic of 1901, the April 1906 earthquake that devastated San
Francisco contributed to the market instability, prompting a great flood of money
from New York to San Francisco to aid reconstruction.
A further stress on the money supply occurred in late 1906, when the Bank of
England raised its interest rates, partly in response to the UK insurance companies
paying out so much to the U.S policyholders, and more funds remained in London
than expected (TallmanEllis). From their peak in January, stock prices declined 18%
by July 1906. By late September, stocks had recovered only half of their losses.
In July of 1906, the congress passed the Hepburn Act, which gave the
Interstate Commerce Commission (ICC) the power to set maximum railroad rates,
which depreciated the value of railroad securities (Boyer). This depreciation of
railroad securities caused 7.7% slid in stock market. Between March 9 and 26,
stocks fell a further 9.8%. The economy remained unstable through the summer. A
number of shocks hit the system; the most significant one was the stock of Union
Pacific, which fell 50 points. Until the September of 1907, stocks were lower by
24.4%.
On July 27, The Commercial & Financial Chronicle noted that "the market
keeps unstable ... no sooner are these signs of new life in evidence than something
like a suggestion of a new outflow of gold to Paris sends a tremble all through the
list, and the gain in values and hope is gone" (Bruner.). The fall season was such a
vulnerable time for the banking system—combined with the roiled stock market,
that even a minor shock could have grave consequence. Then in 1907, the panic
began.
The 1907 panic began with a stock manipulation plot to corner the market in
United Copper Company of F. Augustus Heinze, who made a fortune as a copper
magnate. In 1906 he moved to New York City, where he formed a close relationship
with notorious The Wall Street banker Charles W. Morse, who had once successfully
cornered New York City's ice market. With Heinze, Morse gained control of many
banks—the duo served on six national banks, ten state banks, five trust companies
and four insurance firms (Geisst).
Believing that the Heinze’s family already manipulated a majority of the
company, Otto, Augustus's brother, devised the plot to corner the United Copper. He
also believed that a significant number of the Heinzes' shares had been borrowed,
and sold short, with ‘speculators’ who bet that the stock price would drop, from
which they could repurchase the borrowed shares cheaply, pocketing the difference.
Otto proposed a ‘short squeeze’, an economic term for a rapid increase in the price
of a stock that occurs when there is a lack of supply and an excess of demand for the
stock. He believed that the Heinzes would aggressively purchase as many remaining
shares as possible, and then force the ‘short sellers’ to pay for their borrowed
shares. The aggressive purchasing would drive up the share price, and, being unable
to find shares elsewhere, the short sellers would have no option but to turn to the
Heinzes, who could then name their price (Bruner.).
To find financial supporter for the scheme, Otto, Augustus and Charles Morse
met with Charles T. Barney, president of the city's third-largest trust, the
Knickerbocker Trust Company. Barney was willing to provide financing for previous
Morse schemes. On Monday, October 14, he began to aggressively buy shares of the
United Copper, which rose in one day from $39 to $52 per share. On Tuesday, he
asked for short sellers to return the borrowed stock. The share price rose to nearly
$60, but unlike what Otto has expected, the short sellers easily found plenty of
United Copper shares from sources other than the Heinzes; Otto had misread the
market, and the share price of United Copper began to collapse (Bruner.). The stock
closed at $30 on Tuesday and fell to $10 by Wednesday, causing Otto Heinze to go
bankrupt.
The failure of the corner left Otto unable to meet his obligations and made his
brokerage house, Gross & Kleeberg, go bankrupt. On Thursday, October 17th, the
New York Stock Exchange suspended Otto's trading privileges. As a result of United
Copper's collapse, the State Savings Bank of Butte Montana, which was owned by F.
Augustus Heinze, announced its insolvency. The Montana bank had been a
‘correspondent bank’ for the Mercantile National Bank in New York City, of which F.
Augustus Heinze was then president.
However, F. Augustus Heinze's association with the corner and the insolvent
State Savings Bank proved too much for the board of the Mercantile to accept.
Although they forced him to resign, it was too late. As news of the collapse spread,
depositors rushed in to withdraw money from the Mercantile National Bank. The
Mercantile had enough capital to withstand a few days of withdrawals, but
depositors began to pull all the cash from the banks of the Heinzes' associate
Charles W. Morse. By the weekend after the failed corner, there was not yet systemic
panic. Funds withdrawn from Heinze-associated banks were deposited in other
banks in the city.
Besides the Heinze bankruptcy, the 1900s had other economic problems. In
the early 1900s, ‘trust companies’ were booming. The leaders of the successful
trusts were mostly conspicuous members of New York's financial and social circles.
Charles T. Barney, as mentioned above, was one of the most notorious ones, who
owned Knickerbocker. Because of his previous association with Otto and Heinze, his
company, Knickerbocker, went to bankruptcy.
As news spread, other banks and trust companies were reluctant to lend any
money. The interest rates on loans to brokers at the stock exchange soared and,
with brokers unable to get money, stock prices fell to a low not seen since December
1900. By Thursday, October 24, a chain of failures filled the street: Twelfth Ward
Bank, Empire City Savings Bank, Hamilton Bank of New York, First National Bank of
Brooklyn, International Trust Company of New York, Williamsburg Trust Company
of Brooklyn, Borough Bank of Brooklyn, Jenkins Trust Company of Brooklyn and the
Union Trust Company of Providence (Bruner.).
When the confidence of New York's banks hit the bottom because of the
chaos, the city's most famous banker, J.P. Morgan, was out of town, visiting a church
convention in Richmond, Virginia. Morgan was not only one of the country’s
wealthiest bankers, but also he knew how to deal with crisis. As soon as he heard
the news of the crisis, Morgan returned to The Wall Street from his convention. The
morning after his return, everyone came to his office to seek help and to share
information about the impending crisis.
Although Morgan and his associates examined the case of the Knickerbocker
Trust with all their ability, Morgan decided it was too late and regarded it as
insolvent. Its failure, however, triggered chain effects on even healthy trusts, thus
making Morgan take charge of the rescue operation. Morgan conferred
with the United States Secretary of the Treasury, George B. Cortelyou, to help the
Trust Company of America. Cortelyou even said that he was willing to deposit
government money in the banks. It was only the intervention of Morgan that finally
enabled the banks to declare that the panic was over.
However, it was not just Morgan that helped to save the U.S from the panic.
Although Morgan enabled several banks to survive, he knew that the banks must
have additional flow of money to be solvent. Then he assembled the presidents of
the other trust companies and had them agree to donate $ 8.25 million. Furthermore,
John D. Rockefeller, the wealthiest man in America, deposited another $10 million in
Stillman's National City Bank to support Morgan. To instill public confidence,
Rockefeller pledged half of his wealth to maintain America's credit (TallmanEllis).
As the panic of 1907 was the severest economic downfall in the U.S before
the Great Depression, the aftermath of the panic was dramatic; bank panic and
falling stock market resulted in significant economic disruption. Industrial
production dropped further than after any previous bank run. Production fell by
11%, imports by 26%, while unemployment rose to 8% from under 3%
(TallmanEllis).
Since the end of the Civil War, the U.S had experienced panics of varying
severity. Economists Charles Calomiris and Gary Gorton regard the panics
of 1873, 1893, and 1907, and a suspension in 1914 as the worst panics as those lead
to widespread bank suspensions. As the crises repeated with higher frequency and
each time J.P Morgan was too heavily related, people started to concern on the
outsized role of J.P. Morgan; some of them even thought about reform of the banking
system. As a result, in May 1908, Congress passed the Aldrich–Vreeland Act, which
established the National Monetary Commission to investigate the panic and to
regulate banking (Bruner.Robert).
Then the Dow Jones Average remained virtually same throughout the 1910s.
The success goes throughout the 1920s, when the Dow Jones Average increased
amazingly; especially in 1928, the components of the Dow were increased to 30
stocks near the economic height of that decade, thus called the “Roaring Twenties”.
The Roaring Twenties was when the U.S experienced great economic growth
and widespread prosperity driven by government growth policies, a boom in
construction, and the rapid growth of consumer goods such as automobiles. The
economy of the US, which had successfully transitioned from a wartime economy to
a peacetime economy, boomed. However, there were sectors that were stagnant,
especially farming and mining, which causes grave trouble later: The Great
Depression, which the essay will delve into later. The United States raised its
standing as the richest country in the world, its industry aligned to mass production
and its society acculturated into consumerism.
However, in 1929, followed by the Crash of 1929 or Black Tuesday, Great
Depression came along, causing a 90% drop in the whole components of Dow
industry. The severity of the Depression can be assumed by comparing the Dow
level of September 3rd (a month before the Crash) with that of November 13th; the
Dow Jones Average dropped from 381.17 to 198.69. Moreover, the high of
September 3rd would not be recovered until 1954, which is two decades later
(Geisst).
Some economic historians usually consider the start of the Great Depression
the sudden devastating collapse of US stock market prices on October 29, 1929,
known as Black Tuesday. However, other analysts see the stock crash as a symptom,
rather than a cause of the Great Depression.
Even after the Wall Street Crash of 1929, optimism persisted for some time;
John D. Rockefeller said that "These are days when many are discouraged. In the 93
years of my life, depressions have come and gone. Prosperity has always returned
and will again." (Schultz).
In fact, the stock market increased in value in early 1930, returning to early
1929 levels by April, although it was still a little lower than the peak of September
1929 (Vronsky). Both the government and business actually spent more money in
the first half of 1930 than in the corresponding period of the previous year. On the
contrary, consumers, many of whom had suffered severe losses in the stock market
the previous year, lessened their expenditures by ten percent.
By mid-1930, interest rates had dropped to low levels. But people were less
willing to borrow money from the banks, meaning that consumer spending and
investment were depressed. By May 1930, automobile sales, one of the major topsold items during the “Roaring Twenties”, had declined to below the levels of 1928.
Prices in general began to decline, although wages held steady in 1930; but then a
deflationary spiral started in 1931, which changed everything.
Conditions were worse in farming areas; just like the Panic of 1907, which
was aggravated by severe natural disasters, such as the earthquake in San Francisco,
beginning in the summer of 1930, a severe drought ravaged the agricultural
heartland of the U.S Agricultural commodity prices plunged, and in mining and
logging areas, unemployment was high. The decline in the U.S economy was the
factor that pulled down most other countries at first. Then internal weaknesses or
strengths in each country made conditions worse or better. Frantic attempts to
shore up the economies of individual nations through protectionist policies, such as
the 1930 U.S. Smoot–Hawley Tariff Act and retaliatory tariffs in other countries,
exacerbated the collapse in global trade. By late 1930, a steady decline in the world
economy had set in, which did not reach bottom until 1933.
There were multiple causes for the first economic drop in 1929. The causes
include both the structural weaknesses and specific events that turned it into a
major depression and the manner in which the downturn spread from country to
country.
First of all, Irving Fisher argued that the predominant factor leading to the
Great Depression was over-indebtedness and deflation. Fisher tied loose credit to
over-indebtedness, which fueled speculation and asset bubbles (Fisher). He then
delineated nine factors that created the mechanics of bubble pop process. The chain
of events proceeded as follows:
1.
2.
3.
4.
5.
6.
7.
8.
9.
Debt liquidation and distress selling
Contraction of the money supply as bank loans are paid off
A fall in the level of asset prices
A still greater fall in the net worths of business, precipitating bankruptcies
A fall in profits
A reduction in output, in trade and in employment.
Pessimism and loss of confidence
Hoarding of money
A fall in nominal interest rates and a rise in deflation adjusted interest rates
(Coy).
During the Crash of 1929, or the Great Depression, margin requirements were
only 10%. In other words, one could loan $9 for every $1 he had deposited. When
the market fell, brokers called in these loans, but they were not able to get the
money back. Banks began to fail as debtors defaulted on debt and depositors
attempted to withdraw their deposits, triggering multiple ‘bank runs’. Bank failures
led to the loss of billions of dollars in assets. Outstanding debts became heavier,
because the debt remained the same amount although the income was decreased.
Bank failures rapidly increased as desperate bankers asked the borrowers to
give money back, while borrowers could not. With poor-looking future profits,
capital investment and construction slowed or completely ceased. In the face of bad
loans and worsening future prospects, the surviving banks became even more
careful in their lending. As bankers became stingy with loaning, there became less
investment, making a vicious cycle and accelerating the downward spiral.
The liquidation of debt could not keep up with the fall of prices it caused. The
very effort of individuals to lessen their burden of debt effectively increased it.
Paradoxically, the more the debtors paid, the more they owed. This self-aggravating
process turned a 1930 recession into a 1933 great depression (Fisher).
The second theory of causation of the Great Depression was claimed by two
economists of the 1920s, Waddill Catchings and William Trufant Foster, who
influenced many policy makers, including Herbert Hoover, the president of the U.S.
They held that the economy produced more than it consumed, because the
consumers did not have enough income. In other words, wages increased at a
slower rate than productivity augmented. Most of the benefit of the increased
productivity went into the stock market bubble rather than into consumer
purchases.
As long as corporations had continued to expand their capital facilities, such
as their factories, warehouses, or other investments, the economy had flourished.
The Federal Reserve Board even kept the discount rate low, encouraging high (and
excessive) investment. By the end of the 1920s, however, capital investments had
created more plant space than could be profitably spent, and factories were
producing so excessively that the consumers could not purchase enough.
According to this view, the basic cause of the Great Depression was the
overinvestment in heavy industry capacity; compared to wages and earnings from
independent businesses, such as farms, industries manufactured too many products.
Foster and Catchings recommended federal and state governments start large
construction projects, so that the government could re-inflate prices by increasing
the consumer spending. President Hoover and Franklin D. Roosevelt followed the
solution to improve the economic situation.
Economic historians, especially Friedman and Schwartz, emphasize the
importance of numerous bank failures for the cause of the Great Depression. The
failures, they believed, were mostly related to rural America. Structural weaknesses
in the rural economy made local banks highly vulnerable. Farmers, as discussed
above, already were deeply in debt, and saw farm prices collapsing in the late 1920s.
Meanwhile their implicit real interest rates on loans skyrocketed; their land was
overpriced, and crop prices were too low to allow them to pay off what they owed.
Small banks, especially those tied to the agricultural economy, were in constant
crisis even in the 1920s, the “Roaring Twenties” because of the sudden rise in real
interest rates; there was a steady stream of failures among these smaller banks
throughout the decade, while other industries enjoyed never seen success.
The city banks also suffered from structural weaknesses that made them
vulnerable to a shock. Some of the nation's largest banks were having a hard time
maintaining adequate reserves and were investing heavily in the stock market or
making risky loans. In other words, the banking system was not prepared well
enough to mitigate the shock of a major recession.
Other than mere bank failures, economists tried to find other causes for the
Great Depression. They have asserted that the sudden drop in the international
trade after 1930 aggravated the depression, especially for the countries whose
economy was mostly based on foreign trades. They partly blame the notorious
American tariff policy, the Smoot-Hawley Tariff Act for worsening the depression.
They believe that because the Act increased the tariff against all the products from
Europe so much it reduced international trade. Although foreign trade was not a
significant part of overall economic activity in the U.S., it was a much larger factor in
many other countries. The average ad valorem rate of duties on the imports for
1921–1925 was 25.9% but under the new tariff act, it jumped up to 50% in 1931–
1935 (KindlebergerCharles).
In dollar terms, American exports dropped from about $5.2 billion in 1929 to
$1.7 billion in 1933, after the act was executed. Hardest hits were farm goods such
as wheat, cotton, tobacco, and lumber. The collapse of farm exports triggered many
American farmers to default on their loans, leading to the bank runs on small rural
banks that characterized the early years of the Great Depression, as the essay
discussed above.
Unlike many economists, in my opinion, the U.S reaction to the tariff was
excusable; although it triggered an aggravated situation, the U.S’s reaction is still
justifiable. Of course, it is easy to say that a country should keep the tariff for the
international trade down, for the greater benefit for the rest of the world. However,
in such a situation, where the country is suffering from a grave economic danger, it
is not such a weird thing to increase the tariff on the imports; the U.S was just trying
to help itself instinctively; it was one of the defense mechanism for U.S for the Great
Depression. However, it does not mean that the economists from the time made no
mistake. Apparently, the tariff act, while it was an excusable reaction, worsened the
economic situation all over the world, and the economists should not be free from
guilt. I believe the economists should learn from the past incident and when such an
economic downturn happens again, they should avoid making the same mistakes.
Bankruptcy and booming business cycles are thought to be a normal part of
living in a world of inexact balances between supply and demand. What makes a
normal recession or 'ordinary' business cycle into an actual grave depression is a
matter of much deeper debate and concern. Scholars have not come to agree on the
exact causes and their relative importance. Moreover, the search for causes, in my
opinion, is closely connected to the issue of avoiding future depressions.
An even larger question is whether the Great Depression was primarily a
failure on the part of free markets or, alternately, a failure of government efforts to
regulate interest rates, curtail widespread bank failures, and control the money
supply. Those who believe in a larger economic role for the state believe that it was
primarily a failure of free markets, while those who believe in a smaller role for the
state believe that it was primarily a failure of government that compounded the
problem.
In my personal perspective, the Great Depression was caused by failures in
both free market and government. For one thing, it was the government that
allowed the unequal development in industries; while automobiles industries were
booming after WWI and throughout the 1920s, the Roaring Age, the agricultural
industry was going through mayhem. This unequal distribution of wealth must have
been an important key in aggravating the economic situation. The US government
should have controlled a little more to distribute the wealth better, or to encourage
a better well rounded industrial improvement.
However, the government cannot be the only thing to be blamed. After all, it
was the free market, which the contemporaries believed a “perfect system” with the
invisible hand. During the 1920s, and even after the Depression started,
government’s involvement in the market was a heated potato; even the well-learned
economists of the time did not welcome the government’s intervention. Therefore, it
must be correct to claim that The Great Depression was the first time that the error
that capitalism had been suppressing burst into an economic recession; later or
sooner, the Depression were to happen and be solved, just like the slavery problem
in the early America.
The two main factors that lead the U.S away from the Great Depression can
be narrowed to two: Gold standard and the outbreak of the World War II. Economic
studies have indicated that it was suspending ‘gold convertibility’ that did most to
make recovery possible. Each country had its own policies followed after casting off
the gold standard, and the following results varied widely.
Every major currency started not to use the ‘gold standard’ during the Great
Depression; Great Britain was one of the firsts to do so. As the Great Britain faced
lack of gold reserves, the Bank of England declared to give up the gold standard in
1914, and in September 1931 it ceased exchanging pound notes for gold (Tae
GeonKim).
Following Great Britain, Japan and the Scandinavian countries left the gold
standard in 1931. Other countries, such as Italy and the U.S., remained on the gold
standard into 1932 or 1933, with a few other countries in the so-called "gold bloc",
led by France; Poland, Belgium and Switzerland also stayed on the standard until
1935–1936.
According to later analysis, the earlier a country left the gold standard, the
quicker it recovered from the Great Depression. For example, Great Britain and
Scandinavia, which both left the gold standard in 1931, recovered much earlier than
other countries which remained with the gold standard, such as France and
Belgium. The correlation between leaving the gold standard as a strong predictor of
that country's severity of its depression and the length of time of its recovery has
been shown to be consistent for dozens of countries. This partly explains why the
experience and length of the Great Depression differed from the economy of one
country to that of another (Tae GeonKim).
U.S. was able to get away from the Great Depression only after the Second
World War began. The colossal rearmament policies following the World War II
helped stimulate the economies of the U.S and Europe in 1937–39. For example, by
1937, unemployment in Britain had fallen to 1.5 million. The mobilization of
manpower following the outbreak of war in 1939 finally ended unemployment
(KindlebergerCharles).
America's entry into the war in 1941 eventually ended the lingering effects
from the Great Depression in the U.S by bringing the unemployment rate down
below 10% (American Library). In the U.S., massive war spending doubled economic
growth rates, just like what happened in the World War I, both covering the effects
of the Depression and essentially ending the Depression.
During the post-war time, the U.S. seemed to recover its economy. For
instance, in the 1940s, Dow Jones Average saw an increase from 148 to 206. Despite
several uncertainties that followed the Second World War, such as Korean War,
Chinese Civil War, or the Cold War, the U.S economy did not stop its growth; it saw a
200% increase in the average from a level of 206 to 616 in the 1950s (Geisst).
The U.S. experiences a mild recession during the 1960s and 70s. The 1970s is
marked for its economic uncertainty, because of its relationship with the MiddleEastern countries. For example, the Oil Crisis in the 1973 is one of the major
economic downturn that the U.S experienced, which caused a big drop in the graph
of the U.S Dow Jones Average. For the crisis is a major economic incident in the U.S,
the essay will briefly talk about the crisis.
Before talking about the oil shock, however, the basic background of the
crisis is required. On August 15, 1971, the United States resigned itself from
the ‘Bretton Woods Accord’ taking the U.S off the Gold Exchange Standard. Because
only the value of the U.S dollar had been evaluated to the value of gold and all other
currencies were evaluated to the US dollar, it allowed the dollar to "float”. The
industrialized nations then augmented the amount of printed money in amounts far
greater than ever before so that they could stabilize their currencies. As a result the
value of dollar dropped, as well as the other currencies of the world. The oil was
priced in dollars, meaning that oil producers were receiving less real income for the
same price. In the anticipation of devalued oil price, the OPEC stated that forthwith
they would price a barrel of oil against gold, not dollar. Such decision by the OPEC
led to the infamous "Oil Shock" of the 1970s. Until the Oil Shock of 1973, the OPEC
tried to remain the oil price fairly stable versus other currencies and commodities.
However, the price suddenly became extremely volatile thereafter (Perron)
.
The graph above shows how the Oil price went up after the 1973.
The actual Oil Crisis happened when the members of the OPEC, which are
Saudi Arabia, Algeria, Bahrain, Egypt, United Arab Emirates, Iraq, Kuwait, Libya,
Qatar, and Syria, claimed an oil embargo against the U.S. The main reason for the
embargo was because the U.S helped Israel during the Yon Kippur War,
acknowledging Israel as a legitimate state. To be specific, on October 6, 1973, Syria
and Egypt made a surprise attack on Israel. The result of this new Arab-Israeli
conflict was obvious; the price of oil was going to rise. The OPEC nations, which
were the predominant producer of the petroleum, used oil as their weapon against
the U.S. They hugely reduced the amount of oil production, and executed oil
embargo against the U.S, making the world face lack of petroleum. The OPEC nations
declared that they are going to increase the price by 17%. They also declared to
reduce the amount of oil production by 5% each month until the Israel retreats from
Arab occupied territory and Palestine recovers its rights. This triggered a dramatic
inflation all over the world.
For the most part, industrialized economies of the Western world heavily
relied on crude oil, and the OPEC was their predominant supplier. Because of the
sudden inflation of the oil price was experienced in this time period, many
economists blame the price increases, as it suppressed the economic activity over
the world. The targeted countries responded with various innovative and mostly
permanent initiatives to contain their further dependency. The 1973 "oil shock" has
been regarded as the first event since the Great Depression to have a persistent
economic effect (FrumDavid).
I believe the oil shock of 1973 showed the ultimate harmful consequence of
modern forms of guild, the OPEC. Guild in the middle worked as a group of
craftsmen who gathered together to improve the quality of their products. However,
the OPEC, in the name of guild, had gone too far in the 1973. Although I can
understand that oil has been one of the most powerful trading weapons for the
Middle Eastern countries, and it should be acceptable that the OPEC has all the
control over the oil price, it is still not appropriate to manipulate the price of oil, for
it affected the lives of people all over the globe. Such group, which holds a great
influence over the world should have and act more responsibility.
The OPEC, however, should not be the only side getting all the blames for the
oil shock of 1973. The oil shock was the result of selfishness from both the U.S and
the OPEC. For example, one of the reasons that the OPEC decided to augment the oil
price was that the U.S acknowledged and took Israel’s side. The U.S helped Israel in
the 1973 war not because it felt sorry for the fact that Jewish had been wondering
around without their home, but because Jewish held a huge influence over the U.S
with their money; and it was why the U.S supported Israel with modern weapons,
leading Jewish to victory over numerous Arab nations. To set a revenge on the U.S,
who helped its enemy, the OPEC raised the oil price, executing embargo against the
U.S. Therefore, the OPEC cannot be the only side that should get all the blames for
such sudden raise in the price. In my opinion, the oil shock of 1973 can be an
example, which modern economists should look back to solve economic problems of
these days, for modern economic issues are mostly created by a major conflict in
interests.
Unlike the 1970s, during the 1990s, the U.S. enjoys an economic boom that
topped every other major boom that the U.S experienced so far: the Dot Boom or the
Internet Boom. Thanks to the Internet boom, the Dow level increases from 3004.46
on April of 1991 to 10006.78 in March 1999, passing the 10,000 level for the first
time in the U.S Dow Jones Average history. The following graph of the Dow Jones
Average of 1990s shows how rapidly Dow level rose
(Dwilso).
The seemingly unending rise in the stock market came to an end in
September 11th, 2001, when Dow lost over 1369.7 points over a week, or 14.3% of
its total points (Yahoo Finance). Another reason that may explain the sudden
downfall in 2001 is the bubble burst from the IT industry.
What happened was as follows; Over 1999 and early 2000, the U.S. Federal
Reserve increased interest rates six times, which caused the economy to begin to
slow down. The adverse findings of fact in the United States v. Microsoft triggered
the ‘bear market’ to worsen; the result which declared Microsoft a monopoly was
well expected in the weeks before the case was released on April 3.
Another possible cause for the collapse of the NASDAQ was the massive,
multi-billion-dollar sell orders for major high tech stocks, such as Cisco, IBM,
or Dell. This selling resulted in the NASDAQ opening roughly four percentage points
lower on Monday March 13 from 5,038 to 4,879 (NYSE). The massive batch of sell
orders processed on Monday, March 13 triggered a chain reaction of selling that fed
on itself as investors, funds, and institutions liquidated positions.
The poor results of Internet retailers following the 1999 Christmas season
may have correlation with the burst in dot-com business bubble. The public became
aware of the retailers' poor results in March when annual and quarterly reports of
public firms were released. On March 20th, 2000, even financial magazine Barron's
shocked the market with its cover story "Burning Up". By 2001 the bubble was
deflating at full speed (WILLOUGHBYJACK).
As a result of the burst in bubble, many dot-coms went bankruptcy and were
acquired by old-economy competitors or domain name investors. Several
companies and their executives were accused of fraud for misusing shareholders'
money, and the U.S. Securities and Exchange Commission fined such companies
millions of dollars for misleading investors. Various related industries, such as
advertising and shipping, cut down their operations as demand fell. Only few large,
well-known dot-com companies, such as Amazon.com and eBay, managed to survive
the turmoil and were assured of long-term survival.
In 2008, there was a huge real-estate bubble that has influence on the U.S.
market until these days. In my opinion, studying what happened in 2008 economic
crisis will help me predict what is going to happen soon, because the crisis
happened only a few years ago and still has impact on not only overall the U.S.
economy but also the world economy.
In 2008, Lehman Brothers filed for Chapter 11 bankruptcy for the economic
effect of sub-prime mortgage crisis. Before 2008, the U.S. under President Bush
experienced the fall in the cost of mortgage. This housing bubble resulted in
numerous homeowners refinancing their homes at lower interest rates. This
triggered consumer confidence in home owning, because the cost for purchasing
house became lower than paying loans. As the demand for the houses increased, so
did the price of the houses, and this led to boom in construction business. Also, the
increase in the house price meant increase in the ‘equity’. Because people earned
huge amount of unexpected money through buying houses, the increase in equity
caused a consumption culture; people started to buy expensive cars and repair
houses, which required huge amounts of money (BearBaby).
However, as the economy started to boom, there was speculation in the
housing market. In the U.S, there are four classes of credit score, and depending on
the credit score the interest rate is determined. From 720 and up are called
“excellent credit”; 681-720 is “good credit”; 621-680 is “fair credit”; below 620 is
“poor credit” (Credit).
The so-called subprime mortgage is mortgage for those with “poor credit”,
who wanted to buy houses without money, because it seemed like a promising
business. The problem was that the banks loaned money too easily with low
interest; poor creditors started to over speculate on housing market, which caused
bubbles to form; the practice of predatory lending was widespread during the time.
Banks loaned money to poor creditors because back in the mid 2000s, the housing
price increased everyday; bankers thought they could collect their money back
easily by sequestering the house in the worst cases. As even those with bad credits
emerged as a consumption force, the demand for real estate went up radically,
which caused the mortgage market overheated; both good creditors and poor
creditors wanted houses, raising the housing costs radically.
In order to cool down the market, the U.S finance authority increased tax
rates. In 2005, Bush administration proposed that the "government will take in 13%
more in taxes and fees next year than in fiscal 2004." (Center for American
Progress). Later, the Bush administration kept high interest rates from September
1st, 2007 for a year and three months. It was an immediate cause for the mortgage
crisis in 2008, because high interest led to less spending on housing, and less
spending on houses triggered decrease in the cost due to less demand. As the house
prices went down, the bad creditors were not able to pay the loan from the banks.
Some banking organs went bankrupt, and others started to liquidate their
properties to prevent from going bankrupt ("Babybear").
The financial crisis of 2008, however, is not limited to just housing; the
housing bubble may have caused rapid increases in a number of commodity prices.
The price of oil nearly tripled from $50 to $147 from early 2007 to 2008, as the
financial crisis began to take hold in late 2008. Causes for this are not clear, but
several economists attribute the cause to speculative flow of money from housing
into commodities, such as oil. An increase in oil prices diverts a major share of
consumer spending into gasoline, which harms the economic growth in oil
importing countries, such as Korea, while wealth flows to oil-producing states. The
destabilized oil price variance has been regarded as one of the factors in the
financial crisis (Bear).
Others analyze some rabid arguments that the 2008 financial crisis is merely
a symptom of another, deeper crisis, which is a systemic crisis of capitalism
itself. For example, Samir Amin, an Egyptian Marxist economist, claims that there
have been the constant drops in GDP growth rates in Western countries since the
early 1970s. According to Samir Amin, this phenomenon has led to
recurrent financial bubbles, such as the dot-com bubble, and is the deep cause of the
financial crisis of 2007-2010 (Amin).
Then one, including me, must wonder how economists all over the world
could not predict such a huge crisis. Popular articles of the mass media claim that
the majority of economists have failed to predict the financial crisis, thus failing to
fulfill their obligation. For example, a cover story in BusinessWeek magazine even
claims that economists failed to predict the worst international economic crisis ever
since the Great Depression (Coy).
Most economists believe that the financial crisis was simply unpredictable,
supporting the claim with Eugene Fama's efficient-market hypothesis or the
related random-walk hypothesis, which state that the movement of financial prices
are random and unpredictable, because the markets include all the possibilities.
Now, as the essay profoundly discussed the history of the U.S stock market
and Dow Jones Average, let us discuss how we can make fortune out of the stock
market as I promised in the opening. The best way to see how to make money out of
stock market is to look at the recent issue and see how the current issue affected the
market. The best place to begin would be the Korean stock, the KOSPI. Few months
ago, November 23rd, there was an artillery fire from North Korea against South
Korea at YeonPyung Island. As the fire started, the KOSPI, with no wonder,
collapsed; most investors, even economy-educated bankers, believed that there
were going to be a war between North and South Korea, and sold their stock share
with no hesitation; it actually took about 30 minutes to hit the bottom.
However, they were wrong; although they thought they sought through the
state of affairs in Korea, they were nearsighted. The war that they anticipated never
broke out and a few days after the assault, the KOSPI recovered back to the point
before the assault began. The following graph below shows the change in KOSPI:
(Kim).
As we can see from the graph above, which shows the change in KOSPI the
day after the artillery attack, there was a great drop in the very early hour of
November 24th. Most people sold their stocks on that very moment, thinking that
their stocks would not rise again. However, as we can easily see, the graph shows
that the KOSPI recovered back to the original point at the end of the day, with only
couple % off.
This incident gives a clear idea of how to approach the stock market in the
future. Those who really understand the Korean peninsula would buy stocks when it
hit bottom, because they know that the war does not happen that easily. Rather,
they bought all the stocks in a cheap value, knowing that the KOSPI would recover
soon, and got some seed money.
The temporary economic downturn in Korea is an exemplary case in which
one can relate social issue with the economy phenomenon. The financial crisis of
2008 also is an exemplary in which one can look at the social issue that might have
affected the market, and evaluate it. More importantly, both cases require one to
look back at the history of each country’s market; the financial crisis of 2008 can be
solved by looking at the way that the precedents solved their problems; thoroughly
understanding the true atmosphere between North and South Korea could help the
investors to foresee the KOSPI better. As these two independent cases, in addition to
all the minor/major fluctuations in the U.S stock market, show understanding the
history of a country’s market is significant if one wants to make a fortune. I wish this
essay helped the readers understand what the stock market and Dow Industrial
Average are and how to foresee the market by reflecting the history of the stock
market.
Glossary
Speculator: Speculation as an economy term means a financial action that does not
promise safety of the initial investment along with the return on the principal sum.
Speculation causes bubbles. Speculators are those who spread the rumors on a
business, thus creating bubble.
Short squeeze: A short squeeze can occur when the price of stock begins to have
increased demand and a strong upward trend. To cut losses, short sellers may add
to demand by buying shares to cover short positions, causing the share price to
further escalate temporarily.
Short seller: those who execute the practice of selling assets that have been
borrowed from a third party with the intention of buying identical assets back at a
later date to return to the lender. Short sellers try to make fortune from the decline
in price of assets between selling and repurchasing.
Correspondent banking: a relationship entered into between a small bank and a
big bank in which the big bank provides a number of deposit, lending, and other
services
Trust companies: financial institution that perform the fiduciary of trusts and
agencies.
Bank runs: when massive depositors of a bank withdraw money from the bank
because the bank will/may go insolvent, bank run happens.
Gold convertibility: The degree of converting gold can be freely exchanged to
different currencies.
Gold standard: a monetary system in which the standard economic unit of a
currency is a fixed weight of gold
Bretton Woods Accord: Accord that established the rules for commercial relations in
the mid 20th century. It was the first example of a fully negotiated monetary order
intended to govern monetary relations internationally.
Equity: the value of an ownership interest in property, including shareholders' equity
in a business (Naver)
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