Economic Crisis
A stock market is a system that allows traders to buy and sell company stocks, which are collective shares, securities and derivatives (don't worry too much about the mechanics- you don't need to know them within the context of this article). A stock market crash is defined as a very fast drop in prices of stocks listed in the stock exchange, so that most stocks (many of which are owned by traders) become nearly worthless. Simply speaking, when stock buyers buy "stocks" from a company, they give the company a certain amount of money to use for their own purposes. The price of a stock is determined by how much these traders are willing to buy them for- in other words, the higher the confidence in the company's progress, the higher its stock value will be. This is also governed by the laws of supply and demand; the more sought-after a certain share is, the higher the price of that stock.
[1]
Today, the stock market fluctuates up and down all the time. The effects of these fluctuations are relatively small.
[2] However, when the stock market plunges extremely sharply, it becomes an economic crisis. This severe economic crisis could lead to the end of our way of life as we know it. And it has happened before, in what is known as the Great Depression. Read on to find out more about this devastating disaster.
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Sources:
(1) www.investorguide.com/igu-article-818-stock-basics-common-and-preferred-stock.html
(2) Tversky and Kahneman (1974). "Judgement under uncertainty: heuristics and biases". Science 185: 1124-1131.
CASE STUDY
On Black Thursday, October 24, 1929, America's stock market took a plunge and never recovered until November 1964, which was pretty much a quarter of a century later.
How did the plunge come about? It all began directly after World War One. The USA's economy was booming at that time. Because the USA had stayed out of the war for a period of there years, it had time to take over Europe colonial markets. The USA sold necessities like weapons, ammunition, and food to the warring European countries, and also took over the German chemical industry. US bankers and investors were not involved in the war and thus had money to invest in new USA industries. Also, the US lent huge sums of money to the countries fighting in the war, especially Germany, who had to get debt repayments paid according to the Treaty of Versailles.
These factors led to a large-scale boom in USA's economy directly before the economic crisis.
[1] Many people began buying shares, sure that these shares would rise in value (so that they could make a profit selling them at a later date). A portion of them even paid only a tenth of the share price, promising that they would pay the rest after they had made a profit. Indeed, so many felt that the stock market would definitely give a profit, so they bought as many shares as they could. This was to prove fatal.
[2]
At the same time, the booming US industry was running out of customers. Everyone who wanted (for example) a television already had one. The market had too many products sitting on the shelves. Soon the workers, once needed to keep churning out these products, were no longer needed and thus were dismissed. In Autumn 1929, seeing this state of events, the more observant investors predicted that a crisis was imminent. They began rapidly selling what shares they had. The rest of the investors, who were watching these high-profile investors, lost their confidence in the rising share prices as well.
And by 29th October 1929, confidence had all but disappeared and demand for shares was virtually nil, as no one wanted them. Unable to find buyers, investors began panic-selling their shares at low prices and prices tumbled. Banks sold their shares to cover losses made by bankrupt speculators. All this mass-selling led to a crash in the US stock market. Today, this is known as the
Wall Street Crash.
But the worst was yet to come.
The USA was an important figure in the 1920's as many countries that were devastated by the war were relying on loans that were borrowed to reconstruct their economy. For example, Germany's economy had been devastated by the war and the Versailles Treaty. It borrowed loans from the United States to rebuild its economy. However, when the USA market crashed, USA's own economy was failing. Eager to stabilize their economy, the USA called for the return of the loans. This action caused distress and poverty for Germany. Many countries' economies were also severely affected in this manner.
[3] The situation came to be known as the
Great Depression.
There are also some further points of note.
Debt. Many businesses were relying on their profits to pay off the capital of their products. These businesses failed when their goods could not be sold. Banks also failed as people withdrew their savings as they were afraid that the banks would lose money from investments. Many banks then tried to build up their reserves by further investment, which made things worse.
Trade Decline. The decline in international trade in 1930 worsened the depression and countries dependent on foreign trades suffered.
[3]
The U.S Federal Reserve and Money Supply. The U.S Federal Reserve did not react accordingly to the Great Depression and allowed the monetary supply to shrink by a third. By the late 1920s, the Federal could not allow more credit because it did not have enough gold in its possession. After several years in the Depression, even private ownership of gold was illegal.
[4]
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Sources:
(1)http://www.school-portal.co.uk/GroupDownloadFile.asp?GroupId=38244&ResourceId=103692
(2)www.schoolhistory.co.uk/lessons/usa192941/crashcauses.html
(3)http://mars.wnec.edu/~grempel/courses/world/lectures/depressionresults.html
(4)search.barnesandnoble.com/Illegal-Tender/David-Tripp/e/9780743245746
LEARN MORE
Stock market crashes are generally regarded as the result of overanxious shareholders. When there is a general loss of interest for faith in a certain company, or when the major shareholders suddenly withdraw their shares, people start following suit and withdraw theier shares too. This leads to a snowball effect which results in more and more people selling their shares off in a short period of time. The particular company now has a sudden decrease in capital and or may even fall into debt. Having understood that, picture it happening to an entire stock market, a stock market which directly affects the economy of a certain country.
The question is, can this happen today? Postulations have stated that it is
possible. This collapse of world market could be caused by anything: a war, nuclear threat- anything that destabilizes demand, supply, or confidence of the market.
[1]
And even today, when a relatively minor stock market crash happens, widespread panic-selling ensues. In a major stock market crash, the same thing will happen, but with far greater effects. Currencies will devaluate, almost everyone will become poorer, conditions of living will detoriate, and the atmosphere will be one of panic and uncertainty. International ties may be strained because of the desperate rush for resources. If international trade were to be halted as a result, countries relying on trade would begin declining. And as seen from the Great Depression, global problems of widespread poverty and suffering can be brought on by a single economic crisis.
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Sources:
(1)http://books.google.com.sg/books?id=T2QqJzWhCK4C&pg=PA165&lpg=PA165&dq=possibility+of+
economic+crisis&source=web&ots=IvPlcQOVSy&sig=y09CXJ0h7yd4QGnsPYvN7nTu8fc&hl=en
DON'T WORRY!
As bleak as all this might seem, there are already measures in place to prevent crises brought about by massive economic collapse. One example is the International Monetary Fund (IMF) which serves to regulate the economy of the world. Also, governments have back-up plans in the event of such crises. Countries do have their national treasuries and most countries have strategic diplomatic ties with others who can cushion their fall if such a crisis occurs. And while the possibility of such a super-massive global economic crisis exists, the chance of of such an economic crisis happening is small. Therefore, there is no need to panic greatly over this.
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OUR PART TO PLAY
Knowledge from Youth >>
As a teenager, growing up in the country you are in, one thing you can do is to strive to have a good understanding of the stock market. Having an understanding of the stock market is important because it allows you to make clear, intelligent investments. It allows you to understand the risks you are taking when you invest. We're teenagers now, but the time will certainly come when we contribute to the country's economy. Some will contribute a lot, some not quite so much. Some of us will be CEOs of companies, many would be employees, and many of us would delve into stocks and shares. Having a grasp of what can happen in the economic world will definitely give you a cutting edge in life, putting you a notch above others. If all teenagers today are prepared to become responsible investors tomorrow, the future economy of the world is in good hands.
Adults- Responsible Investors >>
As an adult you will be doing far more to help than what you are able to do right now. A simple piece of advice to bear in mind is '
do not panic'. The panic-selling that comes with a small drop in share prices is often the cause of the real stock market crash rather than economic causes. The illusion of a stock market bubble bursting causes people to panic when the share prices drop after a prolonged period of increase, and thus they sell their shares immediately, causing the prices to drop even further. This forms a self-fulfilling prophecy, a cycle of events; people sell their shares because they fear that prices will drop, and these actions cause the prices to drop even more drastically and the economy to fall further. The main message here is to invest wisely. Never invest more than you can spare. Before investing, consider the reliability of a company and whether it is financially stable. Try not to withdraw your shares just because the minority speculates that there will be fluctuations in value. Much knowledge is needed before you actually set forth into the land of risk and potential profits known as the stock market.
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