Why the First Crash Happened: The Speculative Boom and Gambling Instead of Investing

The first stock market crash occurred in 1929. There is much debate as to what caused the market to nosedive. An honest economist will testify that there is no single reason why the market crashed. The truth is that there are a number of catalysts that combined to cause the massive market drop. Let’s take a look at some of the reasons and consider whether it can happen again.

Why the Roaring 20s Came to a Grinding Halt
Most people learn in school that the 1920s in the United States is referred to as the “roaring 20s”. Times were good in the first 9 years of this decade. One could make a nice sum of money doing blue collar work and then make even more by playing the stock market. People observed the financial success of those who invested in stocks and replicated their behavior. Most thought that the stock market was an unbeatable investment at the time. Although in the back of their mind, they knew that the stock market could be volatile and swing downwards, some chose to invest their entire life savings. Others went as far as buying stocks on credit, commonly known as margin buying.

The behavior described above is that of a gambler. Before October 29, 1929, people lacked a healthy skepticism of the stock market. They bought stocks with little research and let the chips fall where they may. Few consulted with investment analysts or read investment literature before buying up as much stock as they could. Unfortunately, the market crashed and these gamblers lost their money. They soon learned that there is a substantial difference between haphazard gambling and performing research for an educated investment.

The Speculative Boom
In the roaring 20s, few people believed that the American economy could falter. It was a time of optimism as World War I had ended. Americans were confident and enthusiastic with their post-war economy. New inventions like the radio and airplane were popping up left and right. It seemed like new technologies were evolving faster than ever and the accompanying high stock prices were a simple reflection of these advances. Yet this was false hope. The stock market boom wasn’t justified in the slightest. Stock prices were pumped up to extraordinarily high values without sufficient reason. The phrase “irrational exuberance”, best describes the roaring 20s. The reality check came with the stock market crash of 1929.

Will it Happen Again?
There are some interesting parallels between the first stock market crash and today’s market. The Dow Jones, NASDAQ and other indexes have been steadily climbing over the past 5 years. Various economic indicators show that the United States’ economy has indeed recovered from its recession. Yet many question whether a trough was really reached in 2009 before the recent upswing.

Why So Many Turn to Stocks
While Americans aren’t pulling their life savings out of the bank to invest it in stocks like many did in the 20s, an alarming number of people are over-invested in the market. If you were to poll working age Americans and ask them how much of their savings is invested in the stock market, plenty would say that the majority of their money is invested. This could be a significant problem if the market crashes again. The problem is that bank account interest rates fail to keep up with the rate that the United States’ dollar inflates. As a result, people either quickly spend their money because it is at its highest value at the current moment or they decide to invest it in stocks, mutual funds and other investments. There is little incentive to save these days. That could prove to be troublesome as we move forward.

A Gamble or an Investment?

It is quite concerning that contemporary Americans and Americans who lived during the roaring 20s are so willing to pour their money into stocks. It is even more concerning that so few people actually research the companies that they are investing in. Americans of both eras fell into the trap of viewing stock ownership as a gamble that pays off in the short term.

The stock market was originally invented to raise funds for businesses that required capital. This heavily conflicts with how people actually view their stock market investments. People no longer act as micro-venture capitalists by buying shares of stock. There are far too many people who look at investing as a quick way to make a buck rather than to actually provide financing that will help companies succeed in the long run. There should be little doubt that another stock market correction and possibly even a crash will occur in the future.