Finance in the 1920s The rocky road to ruin

How a Tariff Works Let us say it cost $10 to make a pair of shoes in the US, and $8 to make (and ship) the shoes from Italy. For American consumers, the Italian shoes, at $8, are cheaper than the $10 American shoes, and they start to buy more Italian shoes, and less American shoes. Congress can “protect” American industry from foreign competition by the use of tariff.

How a Tariff Works Under a tariff, a tariff (or tax) of $4 is added to the Italian shoes, now making them cost $12 in the US. American consumers will stop buying Italian shoes (which are now more expensive) and start buy American shoes, which are now cheaper.

How Stock Works When you buy stock, you are buying a part of the company. Say the Poptart Auto company issues 100 shares of stock at $100 a piece. It will raise $10,000 in capital, and each share represents 1% ownership in the company. (If you own 4 shares, you own 4% of the company)

How Stock Works You can make money in one of two ways. If the value of the stock goes up (people want to own the stock, driving the price up) so you sell it or by dividends issued by the company. Let us say the Poptart Auto company made $500 in profits last years. They keep $250 to invest back in the company (new tools, design and research) and decides to pay the rest in the form of a dividend.

How Stock Works The dividend of $250 is divided among the 100 stock holders, of $2.50 per share. If you have 4 shares, you get $10 in dividends. If the company does well, it can pay a dividend year after year, making a lot of money for the stock holders.

Buying On Time As more consumer products were being made and sold, manufacturers realized that they could sell more products if they sold them “on time”. Rather than wait for someone to save up $250 to buy a car, they could sell more cars by selling them on installment.

Buying On Time They would work out the price (say $250) and the interest (say 5%) and the amount of time (say 24 months) It would then work out in a formula such as this: Price + interest /# of months =monthly payment $250+($250 x 5%)/24 = $10.93 a month

Dow Jones and the Stock Market The Dow Jones Average is changing index (stocks are added and removed over time) of a number of stocks. It is seen by many as a “measure” of the health of the economy. If the Dow goes up, the economy is seen as good. If the Dow goes down, the economy is seen as bad. The Dow is not the best measure, as other factors go into gauging the health of the economy.

Growth of the Dow The Dow is reported as an “index number”. In 1906, the Dow broke “100”. It would be almost 22 years for the value of the Dow to “double” to 200, in 1927. The speculation (people investing in the hope the value of the market goes up) drove the price up to 300 in 1928. Before the crash, the market made it all the way to 381 in 1929.

Dow-Value Sept-Nov 1929

Dow-Volume Sept-Nov 1929

Margin Buying With margin buying, the purchaser only had to put up a small amount of money to invest in the stock market. This brought people into the stock market who could not afford to a downturn in the market.

Margin Buying-An Example Fred wants to invest in the stock market, but does not have a lot of money. He buys a share in Poptart Autos for $100,, but he only has $10. His broker says "don't worry, I'll loan you the rest, $80, using the stock as collateral.” The net value (value of the share minus the loan) equals $20. A minimum margin requirement of $10 is set. If the value of the stock goes up, there is no problem.

Margin Buying-An Example Now, if the stocks stays above $80, all Fred has lost is the $20 he invested, so if he sells now, he will pay off the loan to the broker.

Margin Buying-An Example However, if there is a sell-off (many people trying to sell the stock at the same time) and the price drops to say $40, he will get only $40 for the stock, plus have to find another $40 to pay back the broker.

Institutional Banking The Federal Reserve would loan money to banks at a set rate. That set rate was often much lower than the “market rate” paid by the public. Many banks would borrow money from the Federal Reserve at 5%, and then loan it out at 12%, making a profit of 7% for doing little more than loaning someone else's money.

Dawes Plan In 1923, Germany proved unable to pay the reparations (war debts) of the Versailles Treaty. The Allies needed the money from Germany to pay back the loans owed to the US. The solution was the Dawes Plan.

How the Dawes Plan worked

Dawes Plan The plan worked as long as the US economy was humming along; The Germans and the Allies both became dependent on the US economy and the US market to make enough money to pay back the loan. However, “Protectionism” in the US got in the way

Fordney-McCumber Tariff In order to protect American markets, the Fordney-McCumber Tariff was passed in 1922. The goal of the tariff was to raise the cost of a foreign product enough so that Americans would buy American products. The problem is that European nations, which need to sell exports to raise money, have a harder time selling goods, leading to problem is paying debts and reparations, leading to an economic crisis

Fordney-McCumber Tariff It also led to a loss of foreign markets for American manufacturers, as other nations retaliated by raising their own tariffs, choking off free trade between nations. Allied nations trying to repay war loans, and Germany try to repay reparations find it harder to raise money.

Overproduction in the 1920s When the economy is growing strong, many companies try to get a product to market and make a profit. In the 1920s, there were a number of industries where there was “overproduction”. What this means is that more items (cars, radios, washing machines) were produced then were needed. The companies that could not compete (their product was too expensive, quality was poor) failed.

Overproduction in the 1920s In automobile manufacturing, a large number of car companies went out of business. Some produced a few cars, some produced thousands of cars. Among them were such names as: Cole Motor Cars Columbia Motor Cars Barley Motor Car Huffman Brothers Motors Liberty Motor Cars Moon Motors Cars Locomobile Wills Sainte Claire

Wealth Distribution One of the problems was that while the US was rich, the distribution was not equal. The rich were very rich, and the poor were very poor. In 1929 the top 0.1% of Americans had a combined income equal to the bottom 42% The top 0.1% controlled 34% of all savings in the US. In contrast, 80% had no savings at all

Wealth Distribution Some people made far than others. While an extreme example, we can look at the income of Henry Ford, and an average person, such as Fred, our investor. Henry Ford reported a personal income of $14 million in 1929, while the "average" person earned around $750. In 2005, "average" income is around $32,000, meaning Henry Ford would earn around $597 million a year.

The Really, Really, Really Rich By way of example, the highest paid CEO of 2005 was Richard D Fairbank of Capital One Financial, making $249.42 million. (That’s $7.91 a second!) Forbes has a list of the 400 richest Americans. For the first time, everyone on the list is now a BILLIONAIRE. A billion dollars is a lot of money. If you spent $100 a minute, it would take almost 20 years to spend it. If the money earned interest (say 6% a year) you could never spend it all.

But If Your Were Going to Try… The Saleen S7 for $397,000