Causes of the Great Depression

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Causes of the Great Depression

Introduction

The Great Depression denotes a period of global economic depression, which occurred in the period before World War Two. Different nations were hit by the depression in different times, but the depression generally started in 1930 among most nations. The depression persisted till the late 1930s and middle 1940s in some nations. This was the most widespread, deepest and longest depression in the 20th century. The Great Depression is commonly cited in the 21st century as a happening exemplifying how far and worse the world economy can decline (McElvaine 72). The origins of this depression can be traced back to the United States, and its onset was marked by the decline of stock prices, which began on September 1929. The crash in stock prices turned into world news on October 29th of the same year-a day later termed as the Black Tuesday. The depression caused devastation in both poor and rich nations across the globe. Prices, profits, tax revenue and personal income declined while international trade plummeted by approximately 50% percent (Terkel 41). The levels of unemployment in the United States increased by 25% and in some nations this went as high as 33% percent. Many big cities in the globe were adversely affected, especially those whose dependency was on heavy industry. The rural areas and farming were adversely affected as the prices of agricultural produce fell by an estimated 60% percent. The construction industry almost froze in most nations. Faced with declining demand and diminishing alternative sources of jobs, the places that were dependent on primary industries including logging, mining and cash cropping were hardest hit. After a prolonged period of hardship, some economies began recovering in the mid 1930s. However, in some nations the negative impacts of the depression persisted till the end of World War Two (Terkel 104).

Historians in the field of economy attribute the onset of the depression to the impact of the collapse of the United States’ stock market prices, which occurred on the Black Tuesday (Boundless 1). However, some dispute this attribution and conclude that the stock market crash was just one among many causes of the depression and just, but a symptom rather than an actual cause of the devastating occurrence (Terkel 98). Nevertheless, a lot of literature on the causes of the depression cites the crash as one of the reasons among many that shall be outlined in this paper.

Causes of the Great Depression

The Crash of the Stock Market

Even though the stock market is known for being a risky investment, this did not appear to be the case in the 1920s, when the number of stock buyers increased by the day. The United States was in an exuberant mood in the early 1920s and the stock market was deemed an infallible future investment. More and more people made investments in the stock market and as they did so the stock prices began going higher by the day. This first became notable in the 1925. Later on, prices went on an up and down trend during 1825 and 1926, and in 1927 a strong upward trend was recorded. This strengthened bull market lured even more investors, and by 1928 a stock market boom had been realized. The more the stock market grew, the more people were enticed to invest more money into it (Boundless 1; (Terkel 84). A large number of the people buying stocks bought ‘on margin,’ which means that they only paid for part of the worth of the stock on purchase and the rest when they made a sale. This trend worked favourably as long as the stock prices kept soaring. However, when the stock market finally crashed, the buyers were compelled to pay up on stocks that were not anymore worth a thing. Most of these stock holders had borrowed from banks to fund their stock purchases, and as the stock market crumbled, they were unable to repay the banks loans borrowed to purchase the stock (Boundless 1). As a result, the banks were left protecting empty coffers. By Black Thursday the value of common shares and stock had dropped by 40%. This devastating drop set in motion a downward spiral. The downward spiral changed future expectations and sentiments and thus changing the outlook from positive to negative. Experts in the field of economy dispute how much weight to assign to the crash of the stock market in October 1929, but nonetheless it is clear that the stock market crush is one of the major causes of the Great Depression (Boundless 1).

Bank Panics, Failures and Monetary Contraction

The failures in the international credit structure were also another cause of the Great Depression. In the end of the First World War, European nations owed large amounts in debt to American Banks (Pells 1). Many major United States’ banks had extended credit to European nations that were hard hit with the First World War and could thus be less able to repay their loans. These large debts were however rarely paid thus crippling most large banks. Smaller banks in the United States were also crippled because many farmers that had debts could not pay their debts. Most banks, especially in the rural settings had overextended credit to small scale farmers that did not share in the 1920s prosperity and were often unable to pay the loans. As times grew tough American banks stopped offering credit and the European countries defaulted. Many outstanding loans went unpaid and the result was widespread bankruptcy within banks that could not secure what was owed to them. In fact, some of the banks went out of business because deposit holders panicked and decided to take out their savings en masse and thus causing massive bank failures. The panic that ensued and massive closures almost shut the entire country’s banking system. The failure of the banking system started in October 1930-a year after the crash. The banking system could not be salvaged because the federal deposit insurance did not exist at that time and as such failure of banks was a common occurrence. The fears that sparked this trend led to massive withdrawals from banks. The increasing withdrawals led to a decrease in the money multiplier, which implies that a slow circulation of money followed. This problem led to a decline in money supply. The problem also led to a significant decline in aggregate investment and an increase in interest rates (Pells).

According to Pells, the next big blow took place during the fall of 1930-a time when the first waves of the banking panic hit the US. Panics start when a large number of deposit holders lose their confidence in a bank’s solvency and make requests to have their deposits be paid out to them in form of cash. Banks typically hold only a portion of the deposits in the form of cash. As such, they have to liquidate their loans so as to raise the demanded cash. The pursuit of fast liquidation may even make a previously solvent banking institution to fail. The US encountered widespread panics in the banking sector in the fall of 1930 and in the fall and spring of the following year as well as in the fall of 1932 (Terkel 63). The last wave of panic persisted through1933 and ended with the declaration of the national ‘bank holiday.’ The “bank holiday” declaration was made by Franklin Roosevelt in 1933. This declaration led to the closure of all banks. The banks were later allowed to reopen after the government proved that they were solvent through government inspection. These waves of panic and their associated impacts took a great toll on the US banking industry as a whole and by 1933 a fifth of the banks open in 1930 had failed by 1933 (Pells).

Naturally, the banking panics that led to such occurrences are by and large inexplicable and irrational events, but a few of the contributory factors are explainable. Specialists in economic history are of the idea that significant increases in agriculture-based debt in the 1920s accompanied with American policies, which promoted undiversified, small banks led to the development of an environment that could ignite and spur such panics. The large farm-related debts originated partly from the big prices of agricultural inputs and goods during the First World War that had increased widespread borrowing by United States’ farmers that wished to multiply their production through making investments in machinery and land. The decrease in farm commodity prices after the war made it challenging for American farmers to sustain their loan repayment.

The role of the panics in causing the depression was further spurred to greater heights when the Federal Reserve put little effort in trying to reduce the panics in the banking industry. Economists Schwartz J. Anna and Friedman Milton argue that the demise of Benjamin Strong in 1928 was a major reason for this inaction (352). Strong was the Federal Reserve Bank governor in New York since 1941, and he was a forceful governor that comprehended the capability of the central bank in limiting panics. However, the demise of Strong created a power vacuum, which allowed other players in the Federal Reserve office with less sensible views to prevent the undertaking of due interventions. The ensuing panics led to an increase of the currency to deposit ratio, which caused a decline in the money supply in the US by 31% percent by 1933. Additionally, the Federal Reserve contracted money supply and increased interest rates in 1931, when the UK was compelled to stop using the gold standard. This made investors fear that the US would go into devaluation as well. Economic experts