The Market's Memory

Under a buttonwood tree on Wall Street, twenty-four brokers sign the Buttonwood Agreement (1792): the future NYSE is born. A century of recurring panics follows —1837, 1857, 1873, 1893, 1907— with no lender of last resort. When trust in credit broke, there was no institution to halt the fall: only the will of a private individual.

In 1907, J. P. Morgan gathers the bankers in his library and organizes the rescue with his own capital and that of his peers. The panic is stopped by a private, not public, decision. From that fragility the Federal Reserve (1913) is born: for the first time, an institutional lender of last resort. (In 1912 the Titanic sinks; we merely note the temporal coincidence, with no theory attached.)

When the Great War breaks out, the NYSE closes for nearly four months —the longest shutdown in its history— to halt the massive asset liquidation by Europeans. When it reopens, money and industry have quietly reorganized.

The war sectors —steel, chemicals, munitions, railroads and the banks financing the Allies— surge; the laggards fall behind. The U.S. shifts from debtor to creditor of the world.

With the war over, a short, sharp depression (1920–1921) arrives: brutal deflation, prices and wages fall hard, the over-leveraged of the war boom go bust. Almost without state intervention.

It was the cleansing that left the ground cheap before the decade's great boom.

Electricity, radio, the automobile and consumer credit. The market rises almost vertically, fed by buying on margin —up to 90% of the capital borrowed—. The glamour stocks are born: RCA, automakers, utilities. Euphoria is mistaken for permanence.

The leverage that drives the rise is the same that guarantees the violence of the fall.

Black Thursday (Oct 24), Black Monday (28, −13%) and Black Tuesday (29, −12%). The mechanics of margin in pure form: as the price falls the margin calls arrive; the leveraged investor must sell to cover; that forced selling drops the price further and triggers new margin calls.

A self-reinforcing spiral: it's not caused by pessimism, it's caused by debt.

From the 1929 peak to the 1932 bottom, the Dow falls about −89%. Waves of bank panics arrive: thousands of banks fail, credit evaporates and money with it. With no deposit insurance yet, savings vanish.

What got destroyed were the leveraged, the fragile banks and everyone who had to sell at the bottom.

Bretton Woods (1944) sets the monetary order: the dollar anchored to gold and the other currencies to the dollar. The safety nets of the 1930s —deposit insurance (FDIC), the SEC, banking regulation— reduce structural fragility.

A long, stable industrial and consumer boom follows: for the first time the system has shock absorbers designed so that 1929 doesn't repeat.

On August 15, 1971, Nixon closes the gold window: the dollar stops being convertible. A detail almost no one highlights: the next day the Dow rose —the market celebrated the announcement—. The damage wasn't that session.

The damage was the new regime: fiat money and, in the following decade, stagflation, double-digit inflation, the oil embargo (1973) and gold soaring. The asset that protected wasn't the index: it was gold and energy.

On October 19, 1987 the Dow falls −22.6% in a single session: the largest daily percentage drop in history. The trigger is technical —program trading and the automatic "portfolio insurance" that sold in cascade—.

Difference from 1929: Greenspan's Fed acts immediately, floods liquidity and backstops the system. It doesn't turn into a depression: the market recovers in months.

Dot-com (2000): leverage of expectations about the internet; the Nasdaq falls about −78% from the peak. 2008: leverage of credit —subprime mortgages, securitization, shadow banking—; Lehman fails and trust in credit breaks again. The same knot as 1907 and 1929.

The difference: this time the lender of last resort acts at massive scale —bailouts, TARP, QE, zero rates—. The same logic of leverage and credit; a different outcome because of the intervention.