Good morning scholars. Thank you to the students who were able to attend the in-class session. Here is a summary of the lecture:
We are currently experiencing an economic downturn. Within our lives we've seen another contraction in 2007-2008, with earlier contractions in 1988 and of course during the period we are currently studying: The Great Depression.
Classical economics calls this the contraction side of a Kuznets cycle. However, classical economics says these cycles are caused by variations in the supply TRENDS of labor and other resources; variations in productivity TRENDS relating to efficiency with which those supplies are used; and variations in the average intensity with which resources get used-- in other words variations in rates of unemployment. (Economics, Samuelson, McGraw-Hill, 1967. P. 244)
The Samuelson text goes on to say that fiscal policy can provide relief for these conditions. As you progress in your education you'll hear this called Keynesian Economics. In your heart you probably realize fiscal policy isn't going to be enough.
The definition used to explain these contractions isn't adequate as it did not recognize shocks to the system. In this current contraction we can see that people want to work and that there is a demand for goods and services (for example, the shortage of toilet paper, facial tissue, anti-bacterial wipes and hand sanitizer). But the virus has made it dangerous to work, and this change was sudden.
The Great Depression was similar. And it was different too.
Big economic shocks to the system are accompanied by large-scale destruction of wealth, or in this case, in the destruction of people's ability to work. We're not able to produce because of fear of death. In the Great Depression people were unable to work because money and credit disappeared. Here's what happened.
During the 1920s the Western economies absorbed the return of men from the World War. Particularly in the United States this was followed by an extended period of economic growth. At that time people saw the stock market rise spectacularly. To give numbers to this statement, the market rose 307.6 percent from January 1, 1918 to January 1, 1929. If you had reinvested your dividends the return for that period was 608.0 percent.
On an annual basis this amounts to more than 13 percent annual return, more than 19 percent if you include the dividends. However the people investing were not sophisticated. By that I mean they were new to the market, didn't understand the risk of investing... Sort of like asking you to invest.
At the time there was a widely used and widely touted tool called buying on margin. Margin still exists today, but there are rules that limit its use. That wasn't true in the 1920s. Anyone, including children, could buy on margin. And people did buy on margin. Here's how it worked:
Let's say that I wanted to buy on margin and the stock I wanted to buy was selling at $100 a share. I have $10 to invest. The broker would loan me $90. Like a modern loan I would need to pay interest on the loan, but it would be secured by the stock. This was heavily touted by stockbrokers to investors. The stock brokerage made money on the loan and on the sale.
For the individual investor, a change of as little as ten percent could cause your investment to double. For example, if the stock increased ten percent to $110, I would still have a loan of $90 but now I'd have $20 of stock, net of the loan. My investment had doubled!
The 1920s, as I noted, saw annual increases in stock prices of more than 13 percent, even without the dividends. WOW! Who wouldn't try to get rich this way? Here's the downside: A loss was also multiplied. For example, a ten percent loss in the stock would cause my investment to disappear, and I would still owe $90 in a loan.
On October 29, 1929 the stock market started to sink. (It had actually hit a peak about six weeks before). As stocks fell the brokers called their customers demanding they bring their margin accounts into compliance, meaning the customers had to put up ten percent of the value of the loans.
Investors sold some stock to meet the margin requirements. However as you may be aware, if there are more sellers than buyers, the price of a stock will fall. That day, across the market, there were points when there were no buyers, just sellers. It was the greatest downturn in stock market history.
People then turned to their bank accounts to make good on the loans. However, banks operate on making profit by loaning the money you save to others. (There is a great explanation of this in the movie It's a Wonderful Life (https://www.youtube.com/watch?v=iPkJH6BT7dM).
Bank runs started. Without money, business ground to a halt, farmers could not get loans, people lost their homes, their farms and their jobs. It should all sound familiar to you.
You are a generation seeing and living through what may be the worst economic disaster the country has ever endured. And it will have an effect on you. You will be talking about all kinds of lessons from this period, just as my parents did (they were teens and young adults during the Great Depression).
They said things like, never trust the banks, keep some money under the mattress. They hid money behind pictures and always kept cash on hand. They hoarded string, rubber bands and paper bags. They were careful with money to a fault.
What lessons will you share when you are my age, talking to children who will then be your age today? Make sure you stock up on toilet paper, hand sanitizer, sanitizing wipes and paper towels? Don't shake hands with strangers? Always wash your hands?
My parent's generation has passed and the children then would be a century-old if they are still alive. But they keep to their frugal ways. Those were tough times. They endured and lived to see the US rebuild to even greater heights and meet even more desperate times. And so will you.
We are currently experiencing an economic downturn. Within our lives we've seen another contraction in 2007-2008, with earlier contractions in 1988 and of course during the period we are currently studying: The Great Depression.
Classical economics calls this the contraction side of a Kuznets cycle. However, classical economics says these cycles are caused by variations in the supply TRENDS of labor and other resources; variations in productivity TRENDS relating to efficiency with which those supplies are used; and variations in the average intensity with which resources get used-- in other words variations in rates of unemployment. (Economics, Samuelson, McGraw-Hill, 1967. P. 244)
The Samuelson text goes on to say that fiscal policy can provide relief for these conditions. As you progress in your education you'll hear this called Keynesian Economics. In your heart you probably realize fiscal policy isn't going to be enough.
The definition used to explain these contractions isn't adequate as it did not recognize shocks to the system. In this current contraction we can see that people want to work and that there is a demand for goods and services (for example, the shortage of toilet paper, facial tissue, anti-bacterial wipes and hand sanitizer). But the virus has made it dangerous to work, and this change was sudden.
The Great Depression was similar. And it was different too.
Big economic shocks to the system are accompanied by large-scale destruction of wealth, or in this case, in the destruction of people's ability to work. We're not able to produce because of fear of death. In the Great Depression people were unable to work because money and credit disappeared. Here's what happened.
During the 1920s the Western economies absorbed the return of men from the World War. Particularly in the United States this was followed by an extended period of economic growth. At that time people saw the stock market rise spectacularly. To give numbers to this statement, the market rose 307.6 percent from January 1, 1918 to January 1, 1929. If you had reinvested your dividends the return for that period was 608.0 percent.
On an annual basis this amounts to more than 13 percent annual return, more than 19 percent if you include the dividends. However the people investing were not sophisticated. By that I mean they were new to the market, didn't understand the risk of investing... Sort of like asking you to invest.
At the time there was a widely used and widely touted tool called buying on margin. Margin still exists today, but there are rules that limit its use. That wasn't true in the 1920s. Anyone, including children, could buy on margin. And people did buy on margin. Here's how it worked:
Let's say that I wanted to buy on margin and the stock I wanted to buy was selling at $100 a share. I have $10 to invest. The broker would loan me $90. Like a modern loan I would need to pay interest on the loan, but it would be secured by the stock. This was heavily touted by stockbrokers to investors. The stock brokerage made money on the loan and on the sale.
For the individual investor, a change of as little as ten percent could cause your investment to double. For example, if the stock increased ten percent to $110, I would still have a loan of $90 but now I'd have $20 of stock, net of the loan. My investment had doubled!
The 1920s, as I noted, saw annual increases in stock prices of more than 13 percent, even without the dividends. WOW! Who wouldn't try to get rich this way? Here's the downside: A loss was also multiplied. For example, a ten percent loss in the stock would cause my investment to disappear, and I would still owe $90 in a loan.
On October 29, 1929 the stock market started to sink. (It had actually hit a peak about six weeks before). As stocks fell the brokers called their customers demanding they bring their margin accounts into compliance, meaning the customers had to put up ten percent of the value of the loans.
Investors sold some stock to meet the margin requirements. However as you may be aware, if there are more sellers than buyers, the price of a stock will fall. That day, across the market, there were points when there were no buyers, just sellers. It was the greatest downturn in stock market history.
People then turned to their bank accounts to make good on the loans. However, banks operate on making profit by loaning the money you save to others. (There is a great explanation of this in the movie It's a Wonderful Life (https://www.youtube.com/watch?v=iPkJH6BT7dM).
Bank runs started. Without money, business ground to a halt, farmers could not get loans, people lost their homes, their farms and their jobs. It should all sound familiar to you.
You are a generation seeing and living through what may be the worst economic disaster the country has ever endured. And it will have an effect on you. You will be talking about all kinds of lessons from this period, just as my parents did (they were teens and young adults during the Great Depression).
They said things like, never trust the banks, keep some money under the mattress. They hid money behind pictures and always kept cash on hand. They hoarded string, rubber bands and paper bags. They were careful with money to a fault.
What lessons will you share when you are my age, talking to children who will then be your age today? Make sure you stock up on toilet paper, hand sanitizer, sanitizing wipes and paper towels? Don't shake hands with strangers? Always wash your hands?
My parent's generation has passed and the children then would be a century-old if they are still alive. But they keep to their frugal ways. Those were tough times. They endured and lived to see the US rebuild to even greater heights and meet even more desperate times. And so will you.
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