The Great Depression was a pretty depressing time and since the stock market has been tanking for the past month, I decided to research and learn more about what happened during the roaring 20s and what lead to the Great Depression.
My anxiety levels only rose as I managed to find some similarities between what happpened in 1929 and what is going on now in 2021. But it could just be a mixture of confirmation bias and the Baader-Meinhof effect.
So here are the various factors that lead to the Great Depression.
Warning: You might become a bear after reading this. You have been warned. 🐻📉
1. Buying Stock on Margin
Margin was one of the main causes of the stock market crash in 1929. Margin was available for 50% which meant that people only had to put up 50% of the cost and the broker would put up the rest of the money.
Fo example, here’s how margin worked. Let’s say you want to buy TSLA stock which currently trades at around $420. with 2:1 Leverage, you would only have to put in $210 of your own money to own the TSLA stock. However do note that you also have to pay interest on your margin.
So if TSLA Stock went up to $800 and you wanted to paper-hand you TSLA stock. You would get to keep all of your profits. So after selling your account would be worth 800.
However, you have to pay back your margin of $210, so now your account is worth 590. So while TSLA stock increased by 90% from 420 to 800. Your account increased by 180%. So this is why people use margin to amplify their gains. But it also works in reverse.
Let’s say that Elon Musk tweets “Tesla Stock is Too High IMO” on Friday 5 mins before the market opens. TSLA Stock crashes from 420 to 300. Although you have diamond hands and decide to become a long term investor since you like the stock, margin calls exist. This depends on each broker.
If your broker has lets say 35% as maintanence margin, that means that when your own money is less than 35% of your account, you will either have to deposit more $$$ into your account to keep the percentage above 35% or all your positions would be sold. That means if TSLA dips below 323, you will be margin called as if you minus the 210 of debt. your actual money is just 113.
This means that even though TSLA only dipped by 23%, your account fell by 46%. So this is basically what happened in 1929. But the margins were more like 3:1.
So since stocks went down and people were on margin, to be precise 300 Million Shares were on margin. So since production was unable to meet the optimism and frenzy in the stock market. Stocks began to tumble downwards, this lead to margin calls being issued and since people were not able to deposit more money as wages did not increase because of low production, people had to liquidate or sell their stocks. This selling stocks to tumble further and more margin calls being issued leading to a cycle. A very bad cycle.
The money supply in the us increased by 24.6% from around 15 trillion dollars to 19 trillion. And it is expected to grow another 5 trillion in 2021 because of various reasons like the stimulus and various other development reasons. The s&p 500 increased by 22% from jan 2020 to March 2021 while the Dow Jones increased by 14.47% in the same period.
Since the economy is reopening and people are going to buying products again, this can lead to supply shortages leading to way more inflation and this can lead to the fed increasing interest rates. This could lead to deleveraging.
Also the US can’t just print more money since the additional printing would just lead to even more inflation which is the problem. This is terrifying situation for the financial institutions and everyone and in a depressing way, bitcoin might reach a million dollars.
But the fed thinks that people would wait and not pay higher prices. This would lead to people just waiting until supply increases and again and pay the same price which would prevent inflation and thus a global economic depression.
One reason the stock market crashed is cited to have been overvaluation of stocks, but this wasn’t really obvious.
However, there was some sentiment in the media and government that stocks were becoming overvalued.
Comparing it to the present day. This could potentially be stocks like Tesla. Tesla and Nio reached a peak market cap of 940B Dollars even though they sold only 540 thousand cars in 2020. But while Toyata, BYD, Volkswagen, Daimler, General Motors, BMW, Volvo, Ferrari, GWM, Stellantis, Hyundai and Ford have a combined market cap of 953B, they have sold well over 50M cars combined. So Tesla and Nio are valued about a hundred times over other car manufacturers but this is because of its new technology and dominance in the EV market. T
his is why Micheal Burry is famously short TSLA and said that it could fall 90% to $100 without crashing the financial system. And so far it looks like he is right with TSLA falling by over 35%.
So what do you do now.
Well no one knows whats going to happen. Thats the truth of the stonk market. You can kinda predict whats going to happen but no one really knows. You can take a look at Micheal Burry, the guy famously known for appearing in the big short and also you know predicting the 2008 housing market crash. He was talking about how inflation is going to happen on twitter but deleted all his tweets. However you can still checkout his tweets by searching for micheal burry archives.
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