The Undercover Economist

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What was the relation between the Wall Street Crash of 1929 and the intangible property markets?

This essay will argue that Wall Street and the Wall Street Crash of 1929 are indissolubly connected with intangible property, or assets. Intangible property can therefore be considered as the main cause, effect and accelerator in the crash of 1929. To come to this conclusion, this essay will start with a description of the causes, processes and consequences of the Wall Street Crash of 1929. Second, this essay will offer a comprehensive explanation of intangible property markets elaborating on its different definitions, aspects and scales. And thirdly the links between Wall Street and intangible property will be described. Finally, this essay will conclude with an assessment of how interwound Wall Street and intangible property markets are and how interlinked the Wall Street Crash of 1929 and the intangible asset markets exactly were.

The Roaring Twenties signified a time in the US that the country could get ʻdrunk with the elixir of prosperityʼ (Heilbroner, 2000, p.248). ʻThe United Statesʼs share of world manufacturing production peaked in 1929 at over 42 per centʼ (Meredith & Dyster, 1999, p. 85) with a specifically rapidly growing business in steel and cars. The New York Stock Exchange (NYSE) was the largest stock market ʻfed by higher domestic savings, inflow of short-term speculative foreign capital and the use of marginal share trading.ʼ (Meredith & Dyster, 1999, p.85) Right before the crash ʻIrving Fisher, … a noted Yale economist, famously declared that shares had reached ʻa new and permanently high plateau.ʼʼ (Harford, 2006, p.148) But it was not all that positive. Farming problems emerged around 1925 and markets started to get saturated causing prices to drop. More and more consumers became credit dependent because of paying for goods in installments and taking up major mortgages. All 1

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this led to the creation of an asset bubble. Although not all academics agree on this actually being a proper bubble. Most notably Sirkin (1975) and Bierman (1991) both using Malkielʼs formula (1963) to claim that prices of stocks were not overvalued at this time (Emerson Hall & Ferguson, 1998, p.28)

The start of the Wall Street Crash of 1929 is generally explained in three phases: Black Monday, Black Thursday and Black Tuesday. Consecutively October 19, October 24 and October 29 in 1929. On Black Monday, the New York Stock Exchange was about to plunge but it was not until October 29 - after a successful attempt to stem the decline by the exchangeʼs vice president Richard Whitney on Black Thursday - that the frenzy really started. (Scott, 2003, p.31) The US Federal Reserve eased too slowly and too restrictive exposing frailties in fragmented US banking system that ended up contributing to the process of the collapse, instead of easing it. ʻMonetarists like Friedman and Schwarz (1963) to Keynesians such as Temin (1989) agree that this restrictive monetary policy … was the cause of the initial economic slowdown that eventually turned into the Great Depression.ʼ (Emerson Hall & Ferguson, 1998, p.30) The main factors that led to this collapse excerpted: ʻThe United States had serious balance-of-payments problemsʼ (Kindleberger, 1986, p.162) ʻJust prior to the 1929 crash, NYSE broker loans totaled 9.8 percent of market capitalization.ʼ (Jacobs & Markowitz, 1999, p.175) of which the majority were margin loans that were suddenly called back on a big scale. There were problems in the international monetary system specifically with the gold standard. In the end this gold standard led to wrong parities: overvaluation of British Pound Sterling and undervaluation of French Franc for example. Interest rates were based on domestic rather than international trends and ʻinterest rates rose sharply beginning in the spring of 1928ʼ (Kindleberger, 1986, p.59) Flexible prices and wages created the 2

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increased competition between main financial centers: New York, London and Paris. And long term capital movements that were distorted by reparations and war debts, thus not driven by commercial needs. All of this contributed to the sudden and extreme collapse of the US stock markets in 1929. Heilbroner acknowledges that it were not the stock markets that ʻdamaged the faith of a generation firmly wedded to to the conviction of never-ending prosperityʼ (2000, p.251). But ʻit was the unemployment that was hardest to bearʼ with ʼ14 million unemployedʼ (2000, p.252).

The setbacks this crash caused were significant, especially in Europe, North & South America and Australasia. The effects on the Russian and Japanese economies were a lot smaller. Especially the decline of 46% in GDP in the US was enormous - measured from August 1929 until March 1933 (U.S. World & News Reports, 2008, p.28). The US being the biggest overseas lender at that time:

In 1929, $7.4 billion was made available to the world by the US imports on current

account and capital exports; by 1932 the outflow had fallen by 67 per cent to $2.4

billion.ʼ (Dunning, 1976, p.45)

The impact of this decline in available capital spread wider and faster than expected. Even though the US encouraged investments in the US during the boom in the early twenties, it now started a sharp decline in overseas lending. This presented a huge challenge for the primary producing countries to repay their debts to the US. And while they tried to increase their output, the US decided to ʻinvolve severe measures of economic protectionismʼ (Jackson & Sorensen, 2007, p.36) causing further price depressions. And even another crisis in 1931, caused by export control, problems with the British Pound Sterling and European Reserves.

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To try and recover from these major financial impacts, some other measures followed. The biggest and most significant ones being the suspension of the gold standard. ʻThe Bank of England actually ran out of gold and on 19 September 1931 the gold standard was suspended.ʼ (Chown, 1994, p.269) with the US following in 1933. However, the recovery was still too uneven. World trade was still depressed having too big an emphasis on domestic markets and this economic nationalism led to continuous rejection of free market solutions.

The second part of this essay will explain and elaborate on the intangible property markets with a specific focus on Wall Street before, during and after the 1929 crisis. Intangible property is defined by Hamilton as:

Intangible capital is capital that has an economic value but is not something you can

drop on your foot.

It's the preponderant form of wealth. When we look at the shares of intangible

capital across income classes, you see it goes from about 60 percent in low-income

countries to 80 percent in high-income countries. That accords very much with that

notion that what really makes countries wealthy is not the bits and pieces, it's the

brainpower and the institutions that harness that brainpower. It's the skills more than

the rocks and minerals.ʼ (interviewed by Bailey, Our Intangible Riches, Aug/

Sept 2007)

Or as Smith & Parr define intangible assets: ʻall the elements of a business enterprise that exist in addition to the monetary and tangible assets.ʼ (2000, p.15) The value of intangible property depends greatly on the anticipated future earnings of the entity it represents. So stocks in company X are valued based on the anticipated future earning of that company. This also presents us one of the first major issues with intangible property: the unconnectedness. Because the actors trading the stocks are not the ones that manage the company, we can see a chasm in the precise valuation of the property. The brokersʼ decisions might not have a good impact in managerial terms, whereas 4

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managers might make decision that can have a strong negative effect on the stocks. The two rely on each othersʼ information and anticipation, but act on different premises and principles. This aspect of intangible property will be elaborated on in more detail towards the end of this essay. Another major issue with intangible property is the aspect of goodwill and the preponderance of anticipated future value, rather than reference to actual tangible corporeal property. To put the definition of goodwill in accounting terms:

goodwill is valued as the unidentified residual after the values of the total identified

tangible assets are subtracted from the total value of the subject business. (Reilly &

Schweihs, 1998, p.385)

Since intangible property is intangible and based on the future it is basically impossible to translate it to tangible terms, other than money. Money however is in a sense also intangible, for it is not based on the gold standard anymore but on currency trade and ʻanticipated future earningsʼ of states and their economies. Intangible assets ʻhave a current exchange-value on the money markets or investment markets.ʼ (Commons, 2006, p.160) So not only can intangibility be a problem, but the possibility of adding goodwill to trade creates more issues in valuing property correctly. ʻWhen we determine the selling price of a business we rate the goodwill, which we can not measure or weigh or put in a shop-window…ʼ (Dickson, 1926, p. 339) Goodwill gives actors the option to value their property higher than the standard (accounting) valuation, through putting more emphasis on anticipated future earnings and growth and other external factors involved in giving up their property. Classic example is Carnegie selling his Carnegie Steel Company to the United States Steel Trust - a conglomerate founded by J.P. Morgan and E.H. Gary in 1901 - for $300 million instead of the $75 million that is was originally valued at by the accountants. Carnegie argued that by selling his company, he not only gave up the profits it represented, but also the potential growth and the fact that he was a major competitor in

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the market. He claimed his goodwill of giving up being a competitor and giving up the potential of his company was worth an additional $225 million in this case.

Regular examples of intangible property are stocks, bonds and funds. According to Smith and Parr, the current age is one especially based on information and intangibility. They provide us this short overview showing the development of markets and their approach to products, services and property (2000, pp.1-3): age

characteristics

pre Industrial Age

hunter-gatherer/agricultural

Industrial Age/Revolution

technology/mass-production

Intellectual Property Age/Information Age

cooperation/sharing technologies

Aforementioned preponderance of ʻintangibilityʼ in companies can clearly be seen through some of the case studies conducted by Smith and Parr. They show for example that Procter & Gamble Co. consists for 88.5% of intellectual property and intangible assets, worth $112,906.3 at the time. (2000, pp. 142-5) An even clearer abundance of intangibility is shown by Yahoo! Inc. having 98.9% of their value allocated in intellectual property and intangible assets, worth $46,653.1 at the time. (2000, pp. 144-8)

As influence of intangible property has become so big that it now makes up the majority of assets. The fact that these assets are intangible makes them sensitive to fluctuation and speculation, since their value can be so hard to determine as shown in the Wall Street Crash in 1929 and more recently the global credit crunch in 2008. The creation of intangible assets does not necessarily mean a negative influence; it creates more fruitful markets and even bigger possibilities. However, the enormous reliance on these intangible assets makes them a huge cause and effect that have the ability to create ʻholesʼ or ʻbubblesʼ in markets, both gradually and sudden. 6

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This essay has argued that it was the abundance and volatility of intangible assets that caused the Wall Street Crash of 1929. Consecutively, weak government interference did not manage to subdue the posed problems in the intangible property markets. Wall Street and intangible assets are indissoluble and were therefore the major effect, cause and accelerator in the Wall Street Crash of 1929.

Word count: 1,957

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Bibliography Brynjolfsson, Hitt, Yang, Intangible Assets: How the Interaction of Computers and Organizational Structure Affects Stock Market Valuations, Massachusetts Institute of Technology http://ebusiness.mit.edu/erik/itqo%20final-7-001.pdf Chown, J.F., (1994), A History of Money: From AD 800, London: Routledge Commons, J.R., (2006), Legal Foundations Of Capitalism, London: Lawbook Exchange Dickson, S., (1926), ʻOur Intangible Assetsʼ in The Classical Journal, Vol. 21, No. 5, pp. 337-343, The Classical Association of the Middle West and South, Inc. Dunning, J.H., (1976), American Investment in British Manufacturing Industry, Boston: Ayer Publishing Emerson Hall, T & Ferguson, J.D., (1998) The Great Depression: An International Disaster of Perverse Economic Policies, Michigan: University of Michigan Press Hamilton K., interviewed by Bailey R. Our Intangible Riches: World Bank economist Kirk Hamilton on the planet's real wealth., Aug/Sept 2007 http://www.reason.com/news/show/120764.html Hamilton, K., (2006), Where Is The Wealth Of Nations?: Measuring Capital for the 21st Century, (Washington, DC: World Bank) Harford, T., (2006), The Undercover Economist, New York: Oxford University Press Heilbroner, R., (2000), The worldly philosophers: the lives, times, and ideas of the great economic thinkers (7th ed.), London: Penguin Jackson, R. H. & Sorensen, G., (2007), Introduction to International Relations: Theories and Approaches, Oxford: Oxford University Press

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Jacobs, B.I. & Markowitz, H.M., (1999), Capital Ideas and Market Realities: Option Replication, Investor Behavior, and Stock Market Crashes, New York: John Wiley & Sons Kindleberger, C.P., (1986), The World in Depression, 1929-1939, New York: University of California Press Meredith, D. & Dyster, B., (1999) Australia in the Global Economy: Continuity and Change, Cambridge: Cambridge University Press Reilly, R.F. & Schweihs, R.P., (1998), Valuing Intangible Assets, Grand Rapids: Irwin Professional Scott, D.L., (2003), Wall Street Words, Boston: Houghton Mifflin Company Trade & Reference Division Smith, G. & Parr, R., (2000), Valuation of Intellectual Property and Intangible Assets 3rd Edition, New York City: John Wiley & Sons Inc. U.S. News & World Report (Oct 27, 2008) The Deepest Downturns, 145.9: 28. (viewed on Dec 4, 2008) http://find.galegroup.com/ips/infomark.do?&contentSet=IACDocuments&type=retrieve&tabID=T003&prodId=IPS&docId=A187062415&source=gale&u serGroupName=lom_lakevhs&version=1.0&digest=acb85088689eb1ac94809d54008f8caf

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