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was the 'Greater-Fool' strategy. No matter how high the price is today, there will be a greater fool tomorrow who will buy at an even higher price. For a while, that strategy seemed to work.
To make the game even more exciting, it was common for
investors to purchase their stocks on margin. That means the buyer puts up a small amount of money as a deposit (the margin) and borrows the rest from his stockbroker—who gets it from the bank, which gets it from the Fed. In the 1920s, the margin for small investors was as low as 10%. Although the average stock yielded a modest 3% annual dividend, speculators were willing to pay over 12% interest on their loans, meaning their stock had to appreciate about 9% per year just to break even.
These margin accounts are sometimes referred to as 'call loans'
because the broker has the right to 'call them in' on very short notice, often as short as twenty-four hours. If the broker calls the loan, the investor must produce the money immediately. If he cannot, the broker will obtain the money by selling the stock. In theory, the sale of the stock will be sufficient to cover the loan. But, in practice, about the only time brokers call their loans is when the market is tumbling. Under those conditions, the stock cannot be sold except at a loss: a total loss of the investor's margin; and a variable loss to the broker, depending on the severity of the price fall. To obtain even more leverage, investors sometimes use the stocks they already own as collateral for a margin loan on new stocks. Therefore, if they cannot cover a margin call on their new stocks, they will lose their old stocks as well.
In any event, such silly concerns were not in vogue in the 1920s.
From August of 1921 to September of 1929, the Dow-Jones industrial stock-price average went from 63.9 to 381.17, a rise of 597%.
Credit was abundant, loans were cheap, profits were big.
BANKS BECOME SPECULATORS
The commercial banks were the middlemen in this giddy game.
By the end of the decade, they were functioning more like speculators than banks. Instead of serving as dependable clearing houses for money, they also had become players in the market.
Loans to commercial enterprises for the production of goods and services—which normally are the backbone of sound banking practice—were losing ground to loans for speculating in the stock market and in urban real estate. Between 1921 and 1929, while 494
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commercial loans remained constant, total bank loans increased from $24,121 million to $35,711 million. Loans on securities and real estate rose nearly $8 billion. Thus, about 70% of the increase during this period was in speculative investments. And that money was created by the banks.
New York banks and trust companies had over $7 billion
loaned to brokers at the New York Stock Exchange for use in margin accounts. Before the war, there were 250 securities dealers.
By 1929, the number had grown to 6,500.
The banks not only generated the money for speculation, they became speculators themselves by purchasing large blocks of high-yield bonds, many of which were of dubious quality. Those were the kinds of securities that are difficult to liquidate in a declining market. Borrowing money on short term and investing on long term, the banks were maneuvering themselves into a precarious position.
Did the Federal Reserve cause the speculation in the stock market? Of course not. Speculators did that. The Fed undoubtedly had other objects in mind, but that did not cancel its responsibility.
It was acutely aware of the psychological effect of easy credit and had consciously used that knowledge to manipulate public behavior on numerous occasions. Behavioral psychology is a necessary tool of the trade. So it could claim neither ignorance nor innocence.
In the unfolding of this tragedy, it was about as innocent as a spider whose web 'accidentally' caught the fly.
THE FINAL BUBBLE
In the Spring of 1928, the Federal Reserve expressed concern over speculation in the stock market and raised interest rates to curb the expansion of credit. The growth in the money supply began to slow down, and so did the rise in stock prices. It is conceivable that the soaring economy could have been brought in for a 'soft landing'— except that there were other agendas to be considered. Professor Quigley had said that the central bankers were not substantive powers unto themselves but were as mari-onettes whose strings were pulled by others. Just as the speculation spree appeared to be coming under control, those strings were yanked, and the Federal Reserve flip- flopped once again.
The strings originated in London. Even after seven years of subsidy by the Federal Reserve, the British economy was sagging
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from the weight of its socialist system, and gold was moving back into the United States. The Fed, in spite of its own public condemnation of excessive speculation, reversed itself at the brink of success and purchased over $300 million of banker's acceptances in the last half of 1928, which caused an increase in the money supply of almost $2 billion. Professor Rothbard says:
Europe, as we have noted, had found the benefits from the 1927
inflation dissipated, and European opinion now clamored against any tighter money in the U.S. The easing in late 1928 prevented gold inflows into the U.S. from getting very large. Great Britain was again losing gold, and sterling was weak once more. The United States bowed once again to its overriding wish to see Europe avoid the
