The Concise Guide To Economics
by Jim Cox
25. Black Tuesday
October 29, 1929 is the day the stock market crashed and is commonly viewed as the day that the Great Depression started. The usual explanation for this crash are theories such as overinvestment, an imbalance in the distribution of income and hence a lack of consumption spending, or just a crack-up of the free market.
The overinvestment theory is not fundamental enough to be meaningful--one must ask: What caused the overinvestment itself? The imbalance of income and lack of consumption spending is not only an irrelevancy but also factually incorrect--consumption increased from 73% of GNP in 1925 to 75% in 1929. Quoting Rothbard in America's Great Depression:
If underconsumption were a valid explanation of any crisis, there would be depression in the consumer goods industries, where surpluses pile up, and at least relative prosperity in the producers' goods industries. Yet, it is generally admitted that it is the producers' not the consumers' goods industries that suffer most during a depression. Underconsumptionism cannot explain this phenomenon... Every crisis is marked by malinvestment and under-saving, not underconsumption. p. 58
The failure of the free market is wrong theoretically and historically. The U.S. was not a free market economy; interventions in the economy abounded most importantly in the form of a centralized banking system. In addition, subsidies, income taxes, regulations, tariffs and creation of money out of thin air by the governmentally established central banking system were exceptions to a genuinely free market economy.
The events that did cause the stock market crash are the deliberations relating to the Smoot-Hawley Tariff (which became law in June 1930) being considered by the interventionist Congress beginning in March 1929. (On May 5th 1,028 economists signed a petition asking Hoover not to sign the tariff.) If one tracks the day to day news regarding the tariff--as has been done by Jude Wanniski--the pattern is that the stock market dropped every time it appeared the tariff would be imposed and rallied every time it appeared that the tariff would be defeated. And it became clear the tariff would indeed pass on Monday, October 28th, destroying vast value in stock market shares which then revealed itself when the exchanges opened the next day.
You may wonder how a law enacted in June could cause an event the previous October. One of the determinants of demand for a good (including a stock share) is expectations. The expectations of a severe tariff to be placed on imports reduced the demand for stock shares. The reason an import tariff would reduce the value of an American firm's stock is that investors could understand that the likely result of American tariffs on imports would be a reduction in exports. Quoting from the economists' petition:
Countries cannot permanently buy from us unless they are permitted to sell to us, and the more we restrict the importation of goods from them by means of even higher tariffs, the more we reduce the possibility of our exporting to them...
In other words, trade is a two way street and a barrier stops the traffic in both directions. Additionally, retaliatory tariffs by other countries would further destroy American export sales which would reduce profits of those same American firms. Also, high import tariffs would increase American firms' costs since many were buying foreign products as inputs in their manufacturing processes; again reducing the asset value of the firm.