No. of Recommendations: 7
In celebration of the anniversary of the October 29 stock market crash Mr. Mann points out some the consequences of the Great Depression that followed it. He leaves us with the implication that the market crash was the cause of the Depression, although he acknowledges that this point is disputed.

However, those in-the-know know that the market is a leading indicator of the economy, and not the cause of its behavior. The tail does not wag the dog. People buy stocks because they believe in the future stock prices will go higher, because ultimately they believe the economy and the businesses that comprise it will grow. When they believe the economy will stumble and fall, they sell. Thus the Great Crash was nothing more than a prediction, deadly accurate, of the Great Depression, and indeed the economy did hit bottom three years later in 1932.

What event made it clear to investors that the economy would crash? It was the passage of the Smoot-Hawley Act, which imposed stiff prohibitive tariffs on virtually all foreign goods and trade. This was a purely protectionist measure to respond to popular sentiment at the time. Passed by a Republican Congress, President Hoover did not believe it was a good idea, but he accepted it anyway. The unanimous concensus of hundreds of economists at the time also sounded the alarm, but they too were ignored.

The trade barriers had disastrous global effects, which hopefully is not surprising to Fools. The economy of the US was devastated, but the consequences for nations around the world were in many cases even more catastrophic. For example, the depression in Germany in the 1930s, on top of the punitive provisions of the Treaty of Versailles, set the conditions for the overturn of democracy there and the rise of Hitler to power in 1936. We can add WWII, the Holocaust, 60 million war dead, and the age of nuclear weapons to the litany of disasters that followed Smoot-Hawley.

Meanwhile at home, all the various provisions of a new Democratic Congress as Mr. Mann discusses, that were passed to respond to the Depression, had little effect. The Depression continued unabated until World War II intervened. We are stuck with those programs and their consequences today.

Congress has not entirely learned its lesson not to interfere with the economy. Another recent anniversary is the market crash of October 1987, an event for which some Fools may have a better recollection. The popular mantra then for its cause was the "twin towers" of the US budget deficit and trade deficit. But both of these deficits continued for another decade or longer, while the stock market bounced back in a few weeks.

The real reason was, once again, Congress. The best explanation (so say the editors of the Wall Street Journal) was given by Dr. Ed Yardeni, then chief economist of Prudential-Bache Securities, in an guest editorial in the WSJ about a week or so after the 1987 Crash. It is very much worth reading today.

The House Ways and Means Committee then was considering a Bill to Punish Investors (or speculators) who were (Heaven Forbid!) trying to make money on the merger and acquisition activity at the time. It was also a protectionist measure, intended to protect complacent and incompetent business managers from capitalists who thought they might have better ideas on how to maximize shareholder values and company assets. It would have done so by denying the interest paid to finance a leveraged buyout (junk bonds) as a deductible expense.

Suddenly, the possibility of leveraged buyouts disappeared, and the value of the many takeover candidates collapsed from their projected future value to their current book value. The takeover candidates, close inspection reveals, lead the rest of the market lower, as investors made a mad rush for the door.

Dan Rostenkowski, chairman of HW&M committee, quietly killed the Bill, although he had originally been receptive to it. Alan Greenspan announced the Federal Reserve was ready to fulfill its role as a source of liquidity. And corporate CEO's and Chairmen seeing no impending economic calamity knew the best thing they could do for their shareholders with their corporate cash was to buy their own stock, which at the moment was indeed very cheap. So even though the market convulsions in 1987 were even more violent than in 1929, order was quickly restored.

For all those Fools who like to follow internet and other high tech stocks which have no current net earnings, there is a lesson here. Like the takeover candidates of the 1980's, the prices of the internet stocks include a premium, which today represents your expectation of the dominance of these companies in the future of their respective markets, and not their current balance sheets as viewed by traditional financial analysis. It is an approach attended by risk. Take whatever measures are necessary to keep yourself from being blindsided, including blindsided by your Congress.

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