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What Caused The Great Depression?

By Yann, published on 20/12/2018 Blog > Academia > History > The Great Depression

Generally, when talking about the Great Depression, people tend to see it as an American economic event when, in fact, it affected many countries. Actually, several countries suffered the depression’s aftereffects long after America had more or less recovered!

That’s not to say that the American Stock Market crash of 1929 was directly responsible for individual countries’ long-term economic woes but that event was, at the least, the catalyst that led to that global economic downturn.

Today, when one hears that term, thoughts of 2008 bring shudders.

As worrisome and impactful as that recent event was, it doesn’t compare in magnitude to the economic disaster of nearly a century ago.

Let us now explore what caused this epic event, how it echoed around the world and affected our grandparents.

The Run-Up

Farmers, businesses and individuals all amassed debt prior to the stock market crash In the years leading up to the stock market collapse, many businesses and individuals amassed substantial debt Source: Pixabay Credit: Rilsonav

There are two main schools of thought on the lead-up to that fateful stock market crash:

1. The Keynesian postulate argues that lower aggregate expenditure led to lower income and greater unemployment – an unsustainable economic scenario.

2. The Monetarist stance pins the start of the Great Depression on the banking crisis that caused one-third of American banks to disappear overnight.

Both of these theories place the lion’s share of the blame squarely on the Federal Reserve.

The Federal Reserve, the United States’ central banking system, had only been established some 16 years prior to the 1929 event, ironically as a result of a series of similar – but not so serious financial panics.

Nevertheless, even with this magnificent economic collapse in sight, The Fed neither lowered interest rates nor did they increase cash circulation.

The net result was a country-wide panic. Investors, speculators and anyone who any money in the bank rushed to withdraw it before it could disappear.

Lessons learned: that is why, during the 2008-09 downturn, the American government flooded the market with bailouts and lowered interest rates!

That rush rippled onto the larger stage of national finance: with everyone hoping to sell their shares of stock and nobody buying anything, the market could do nothing but crash.

In a general consensus today, every economist agrees with either the Keynesian or Monetarist view. However, there are other schools of thought, one of which in particular bears mentioning.

Although America did not actively get involved with World War I until the last year, its economy saw a boom by supporting the war effort – even more so when Americans finally joined in the fighting.

In the years immediately after, the country enjoyed great leaps in engineering and innovation: Henry Ford’a Model A was cheap enough for even poor people to afford one, albeit on credit. Whirlpool marketed the first washing machine and, in 1918, William Durant started mass-producing refrigerators for the home.

All of these modern conveniences were well with the reach of most households and the economy hummed along as consumers bought and bought.

The only trouble was that cars, washers, and refrigerators are considered durable goods: they don’t wear out quickly or need to be replaced very often.

Unfortunately, speculation at that time did not involve consideration of what would happen once every household had a car, a fridge, and a washer; that people would simply stop buying – causing factories to over-produce, a lethal combination that would bring the economy to a screeching halt.

The fact that stock prices started falling in early September, well ahead of the actual stock market crash in late October lends credence to this theory.

It is called the Austrian School; a school of economic thought that posits that individuals are largely responsible for such social phenomena.

No matter which theory you subscribe to – or if you contend that there is truth in all three, the Federal Reserve bears the brunt of the responsibility for Black Tuesday.

People flooded into banks for their money in the early days of the depression A run on the bank in New York in the first days of the depression. Source: Wikipedia

Depression: the Immediate Aftermath of the Market Crash

The Stock Market crash of 1929 marked the start of a ten-year stretch of extreme poverty in the US.

Unemployment hovered at around 30% and even farms felt the pinch: who would buy wholesale meat and grain when nobody had any money?

And, as the depression circle the globe, other countries had to abandon formerly beneficial trade agreements to contain their own financial disasters.

American agriculture was further stymied by the dust bowl conditions that plagued the nation’s heartland. The richest, most fertile soil had been reduced to dust by years of poor farming practices and severe drought.

As we saw in the run-up to the 2008 event, economic activity that heralded the Great Depression included generous loans based on optimistic speculation.

By the early 1930s, farmers, including those in the dust bowl region, could no longer meet their loan obligations, meaning that, one by one, banks started to fold, another reason for the aforementioned run on the banks.

Politically, President Herbert Hoover quickly fell out of favour because the hungry, desperate population believed he was not doing enough to turn things around. Franklin Roosevelt won the 1932 presidential election in a landslide victory.

Immediately he set to work restoring the economy through stimulus packages aimed at banks and major industries. With his New Deal, he put the country back to work: building roads, monuments, and city parks.

All across the country, you could see the men of the Civilian Conservation Corps, rebuilding America one stone and shovelful at a time.

President Roosevelt didn’t just turn the economy around with his three Rs; he gave his citizens a sense of pride and purpose.

How were other countries faring during that time?

The Great Depression’s Effects Around the World

To one extent or the other, every country around the world, rich or poor felt the effects of America’s financial fall.

Except for Russia. At that time the globe’s only truly communist country, it relied little on foreign economies. However, it was happy to welcome immigrants from Germany and Finland, who helped industrialise the Soviet Union.

Bear  in mind that Russia had just recovered from its civil war, an outgrowth of the Russian Revolution that brought Lenin to power.

The Depression so rattled Germany that the Weimar Republic could not meet its debt repayment obligations incurred by World War I. The situation was compounded by America withdrawing its financial support.

That, coupled with social turmoil stirred by rising Nazi sentiment led to German banks’ collapse. They lost millions in currency just within the first two weeks of June 1931.

President Hoover’s call to suspend Germany’s debt payments did not sit well with France, a country that, on the whole, was weathering the downturn fairly well – in part thanks to Germany’s payments.

Between suspending the war payments and emergency funding from private banks, among them the Bank of England, Germany was eventually able to pull itself out of its economic crisis, but not before the it extended to Romania and Hungary.

In the absence of speculation and trade with Europe, America attempted to stem its financial haemorrhage while simultaneously unloading over-produced goods and agricultural products by trying to sell them to European countries.

However, the Fordney-McCumber Tariff Act of 1922 put a hefty duty on agricultural products that was meant to protect the American economy had the reverse effect: European trading partners levied tariffs of their own that America could not meet.

As a result of what America perceived as retaliatory tariffs, the Smoot-Hawley Tariff became law in 1930, kicking off a trade war which prolonged the Great Depression in that country.

Thus at a stalemate, American farmers and, on a bigger scale the American economy took far longer to recover economically than European countries, whose agricultural sector had by then recovered enough to produce sufficient food for their citizens.

Food was a matter of contention for colonists in early America; it was but one reason for the American Revolution!

The unemployed seek relief from their government More than 2 million workers found themselves suddenly unemployed when the Great Depression hit the UK Source: Wikipedia Credit: Bundesarchiv

What Happened in Our Land?

Manchester, Liverpool; coal districts and all of the northern industrialised regions were hardest hit by the global economic depression, feeling its effects nearly instantaneously.

Unemployment more than doubled by the end of 1929 while in the northeastern regions, those figures reached 70% due to the shipbuilding industry’s virtual collapse in 1932-33.

Critically, the Labour government, led by Ramsey McDonald, agreed with the May Report that a budget deficit must be avoided at all costs. In spite of more than 3 million unemployed workers and about half of the citizenry depending on the dole, his government raised taxes and cut unemployment benefits by 20%.

Out of work and out of money, the people took to the streets: the 1932 National Hunger March was the first in a series of such demonstrations that ultimately forced the government’s hand into setting up work camps so that men could once again earn their living.

One more event impacted the severity of Britain’s great Slump and the global Depression: the abandonment of the gold standard.

Economists and historians assert that measuring individual currencies against the gold standard was one of the causes of the Great Depression. They further aver that abandoning that rigid standard helped bring about economic recovery. In fact, doing so was one of the famous events in world history where economics is concerned!

The UK was the first to leave the gold standard; other major economies soon followed our lead.

Looking back on that decisive action – valuing currencies on international money markets rather than against how much gold each country had in reserve, proved that the sooner a nation gave up the gold standard, the sooner they recovered economically.

Sandwiched between two world wars was a time of amazing industrial progress, fantastic economic growth and a stupendous amassing of personal wealth: who could blame anyone for believing such progress could trend but upward?

And then, along came the perfect storm of factors:

  • overly optimistic speculation

  • generous credit terms

  • over-production of durable goods

  • high agricultural output

  • no banking oversight

  • loss of confidence in institutions – banks and the stock market

As Americans enjoyed the Roaring Twenties, nobody saw the meltdown coming… but, for years afterwards, everyone around the world felt its effects!

And, while nobody would say that the Second World War was a boon on any level, it certainly lifted the economy out of depression!

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