How much do you know about rebellion in Tudor England?
What about the drug wars in 20th century Mexico, or the Mau Mau revolt in British Kenya?
Quite possibly not that much, and that’s probably fair – those are niche parts of history.
World War Two though – well, everyone schooled in most developed nations has learned plenty about that.
And it makes sense – it’s one of the most destructive, deadly and depressing episodes in history, and it’s also very recent. We must learn about it and we must learn the lessons required to avoid repeating it.
And so, it’s interesting that it’s taken me this long to read JK Galbraith’s The Great Crash of 1929.
For a historian and investor there is surely no more significant topic to understand.
Why? Because of this…
In fact, being introduced to Koyfin which has such good and usable data – for free – from 90 years ago, was one of the first things that really got me curious about this episode of market history. You can sign up here if you like the charts I produce from it.
I am young enough that crashes are just things that happen to test the resolve of investors who would be better off just holding for the long term.
This was, rightly or wrongly, my early thought about investing. I was a Warren Buffetteer, a buy and hold, high quality idealist.
But that was challenged by seeing an 85% decline, where the stockmarket average didn’t return to its previous level for 25 years (or 1958 using inflation-adjusted prices).
I also hadn’t realised that the market didn’t really bottom until 1933 – a ferocious bear market which crushed every dip-buyer, optimist and hopeful soul in the market.
Reading Russell Napier gave a good account of the way in which, even after a 12- or 24-month slide, buying under the belief that the worst was behind them would have left investors with another 60% or more of losses.
I wanted to know more, and so here we are, The Great Crash of 1929.
It’s a great book. Galbraith writes both informatively and entertainingly, which is one of the hardest balances to strike when talking about finance.
First published in 1954, it might be considered an antidote to what Galbraith calls a “common myth among economic historians” who believed that the stockmarket crash had nothing to do with the depression which followed.
To kick off, the thing I found most interesting from the book was the theme of investment trusts. Not a sentence you’ll hear very often, I admit, but please allow me a chance to explain why.
Investment trusts were actively managed vehicles for investing in stocks which allowed anyone and everyone to get involved.
Through the 1920s, they became more popular, performed better and better, and soon there were sub trusts of sub trusts, and you were a complete loser if you weren’t investing in leveraged trusts.
People believed in them as the “democratisation” of investment – no more were equities the preserve of shiny offices on Wall St, they were for everyone.
That was a good thing on the way up, but like a black hole it sucked more and more people in, as their success increased and their fame spread. It’s the most classic story in finance, the last in are the least knowledgeable.
And as Galbraith writes, “it is the genius of capitalism that demand does not long go unfilled”.
So the investment trust business expanded in line with demand, and demand for the vehicles was enough to make them perform well.
In 1928, 186 were incorporated (at the start of the year there had only been 160 in total), and by the middle of 1929, they were coming out at one a day. Many didn’t reveal the stocks they invested in, as to do so might invite “dangerous speculation” in the stocks they invested in – many simply didn’t bother investing at all.
In 1927, $400 million of investment trust securities were sold to the public. In 1929 it was $3 billion.
And this is what gave rise to all those stories we still hear today, of the boy who cleans the knives and books asking for stock tips.
In the contemporary piece which Galbraith quotes, “The rich man’s chauffeur drove with his ears laid back to catch the news of an impending move in Bethlehem Steel, he held fifty shares himself on a twenty-point margin… and stories are told of the Wyoming Cattleman, thirty miles from the nearest railroad, who bought and sold a thousand shares a day.”
And this is not to blame Wall St for the crash or label it evil. Rather, Galbraith writes, Wall St is merely the outlet for an exaggeration of human nature, neither purely good nor inherently bad.
Myths of “organised support” for the market sprung up every time there was a small dip, and they were taken as truth.
In my mind, reading this reminded me loosely of two things today – passive investment, and belief that the Federal Reserve will support the markets (and in fact a recent paper demonstrated this to be true, in the past at least).
In fact, just this morning as I jogged sweatily and slowly around Tooting Common (at 7.30am, choosing the shady side of every road and path to avoid the high levels of solar energy), I listened to the first half of Grant Williams’ recent podcast with Mike Green.
Mike has done a huge amount of work on passive investing, and described a similar phenomenon today as to what happened in the 1920s.
That whole podcast series is easily found and brilliant, especially the one with Russell Napier. Aside from being hugely informative (like his book, reviewed here) it has encouraged me even more to continue reading financial history and incorporating it into my understanding of what’s possible.
But Mike’s insight is that passive funds, which now make up 43% of market cap, mostly owned by younger people, are driving a lot of money into the same narrow sector (tech) because outperformance and momentum are in a virtuous loop.
Because passive is outperforming active, retail investors and money managers alike are having to allocate more and more to passive or risk underperforming (read: losing their jobs). This will work in reverse though, once the forces at play reach their limit.
I believe that what we’re seeing in passive today is equivalent to what Galbraith describes in 1929.
Investors buying indiscriminately into an investment vehicle driving all prices up, based on the idea that the vehicle itself merits outperformance. I think that the investment trust-passive investing comparison is definitely worth thinking about, as the blind are led blindly into troubled waters. More on this soon.
The same way that leverage and confidence increase as prices rise, the self-reinforcing directionality will work against investors with devastating consequences.
If you’re looking for reckless speculation in the 1920s, it was here.
Another interesting theme is policy and government.
Various options are available to the wielders of power in times of trouble, and we are currently seeing the latest upgrade to that arsenal right now.
But back then, dogma triumphed over reality.
Balancing the budget was declared by both Democrats and Republicans to be an urgent need, which allowed no space for fiscal stimulus – tax cuts and spending. In fact, it encouraged the opposite – cuts in spending and increases in taxation.
And meanwhile on the monetary front, devaluing the dollar against gold was considered an international impossibility, and so the deflation in prices could not be halted.
I.e. the two things that we are currently doing in buckets were not considered viable or powerful options.
It’s interesting and helps perhaps to understand why central bankers, seeing data showing “worst decline in this or that since the Great Depression”, have sprung so quickly and dramatically into action.
There is a lot to criticise the Federal Reserve and central bankers of today for, but if we were to offer them a lifeline, avoiding a second Great Depression at any cost may turn out to be a worthy goal, and one we’ll never thank them for if it never materialises. It’s an interesting counterfactual, at the very least.
The book also gives an interesting and detailed descriptive history of the crash, discussing price levels, headlines and volumes of shares traded. It actually begins with a description of the land bubble in Florida.
It was in this period that the Ponzi scheme emerged, as a chap called Charles Ponzi sold lots of “houses” “near” Jacksonville. It was 65 miles from the city. He did believe in good compact neighbourhoods in other regards though – his project comprised lots of land with 23 lots to each acre.
The point that improved transportation opened up the sunny south to all of the US was a good one, but it was taken to excess by property speculators, who were flipping houses or claims on land rapidly in the mid-20s. Galbraith sees the seeds for later speculation in the stockmarket here – the propensity for euphoria was clearly there.
People, as he describes it, bought into the idea that everyone ought to be able to get rich quickly, with little or no effort.
And this turned out to be a fatal one, but the reasoning behind it perhaps lay in one of the widest wealth distributions in recent memory (again – ring any bells?). And with wealth unevenly distributed, the crash of the stockmarket reduced the spending power of consumers by an exaggerated amount.
This is the key point where inequality, the stockmarket and the depression intersect. Because the wealthy had an outsized share of national incomes, and were consequently the major holders of securities, the crashing value of securities affected them first. This made them poorer and had a knock-on effect on the economy.
Galbraith’s closing remarks are these. The American people are still susceptible to the speculative mood, and rising prices can still convey the promise of easy wealth. That rings as true today, if not more so, than when he wrote the words in the early 1950s.
The government has a new arsenal of tools to prevent another 1929, he says, but…
Booms are not stopped until after they have started. And after they have started the action will always look, as it did to the frightened men in the Federal Reserve in February 1929, like a decision in favour of immediate death as against ultimate death. As we have seen, the immediate death not only had the disadvantage of being immediate, but also of identifying the executioner.
A beautiful quote, I think.
My own closing remark would be that when the last crisis is forgotten, the next is not far away. History provides valuable lessons, and warnings, and while “past performance is clearly not a guide to future returns” so to speak, there is much that can be learned from this remarkable episode.
And one thing would be to see what performed well in 1929 – clue, it’s yellow and shiny, and it’s happened again.
I intend to continue my reading of more financial history, but for now it’s the cricket season, which means I’ll be spending eight hours outside in 35-degree heat tomorrow and Sunday instead of in a nice air-conditioned room, sipping ice water and reading.
But where I can steal an hour here or there, I will. And then the reading will begin again in earnest in autumn.
Anyway, I hope you’re all enjoying this European summer with high temperatures and al fresco dining and drinking. They’ve even pedestrianised a bunch of roads around me so that restaurant tables can spill out on to the road. Lovely…