The stock market crash alone did not cause the Great Depression.
What Was the Crash?
The 1920s were marked by a feeling of euphoria among middle-class and wealthy Americans. People began to speculate on risky investments. The Federal Reserve set interest rates artificially low.
Selling Optimism and Risk
Buyers bought stock for a small down payment with borrowed money, planning to sell it quickly at a higher price before needing to pay off the loan.
Market activity led experienced investment bankers to predict an end to high stock values. Then the New York Stock Exchange lost 11 percent of its value on October 24—known as “Black Thursday.” Major banks bought up stocks to keep the prices artificially high.
“Black Thursday” caught few by surprise. People sold their stock at a loss. Stockholders lost over $14 billion in a single day. Banks demanded payment for loans to individual investors. People who could not afford to pay found their savings wiped out.
The majority of Americans—who had not invested in the stock market—lost their savings when the banks failed. Over 90 percent of all banks had invested in the stock market. They lost money and now had dwindling cash reserves. The Federal Reserve was partially to blame for lowering the limits of cash reserves that banks were required to have on hand.
Causes of the Crash
Three main reasons for the collapse of the stock market were international economic problems, poor income distribution, and loss of public confidence.
After World War I, European countries were faced with disastrous economies. The Allies owed large amounts of money to U.S. banks. The U.S. government refused to forgive these loans. American banks gave private loans to foreign governments, who used them to repay the U.S. government. European countries began to default on these private bank loans.
There was poor income distribution among Americans. Only about one percent of Americans controlled over a third of the wealth. There was nowhere for stock sellers to unload their stock. The overwhelming majority of Americans lost their limited savings as local banks closed, and likewise lost their jobs as investment in businesses disappeared.
One of the most important factors in the crash was the panic effect. For much of the 1920s, the public felt confident about future prosperity. Once the panic began, it spread quickly, with cyclical results: people saw the market going down, they sold their stock, causing the market to drop farther.
IN THE AFTERMATH OF THE CRASH
Before the crash, there had been widespread overproduction in the market. After the crash, consumers could not afford to buy products.
People with less money to buy goods could not help businesses grow. Businesses with no market for their products could not hire workers or purchase raw materials. Employers began to lay off workers. Wages dropped. Cities struggled to collect property taxes and were forced to lay off teachers and police.
Source: The Stock Market Crash of 1929
P. Scott Corbett, Volker Janssen, John M. Lund, Todd Pfannestiel, Paul Vickery, and Sylvie Waskiewicz, CC BY 4.0