What were the causes of the Great Depression?
The Great Depression refers to the worldwide economic downturn that lasted for a decade, from 1929 to 1939. It was the most severe and the longest depression ever experienced by the Western world. The main cause of the Great Depression was a decline in spending which resulted in a decline in the production as merchandisers and manufacturers noticed an unexpected rise in inventories. There were various sources of reduction in spending in the US over the period of the Depression, which resulted to an enormous decline in overall demand. The American decline was spread to the rest of the world mainly through the gold standard. Nonetheless, there were a number of other factors that led to the downturn in various countries as discussed below.
Stock Market Crash
The initial reduction in output in the US is widely believed to have been caused by the country’s monetary policy that was aimed at limiting speculation in the stock market. While the 1920s had been a successful period, it was not an exceptionally boom period; the prices of wholesale goods were almost constant throughout, and there were mild recessions in 1924 and 1927. Stock prices had risen by over four times from 1921 to 1929 (Salisbury 22). The Federal Reserve’s raised their interest rates in 1928 and 1929 in the hope to lower the quick rise in the stock prices. In the long run, the interest-sensitive spending was depressed by the higher interest rates in areas of automobile purchase and construction among others, in turn reducing the rate of production.
Towards the end of 1929, the stock prices in the US had reached levels that could not be justified by reasonable anticipation of earnings in the future. Minor events, therefore, led to a gradual decline in prices in October 1929, leading to the loss of confidence by the investors. It resulted to panic selling on October 24, 1929, also known as the “Black Thursday”. Many companies had purchased stock on margin. This forced some investors to liquidation, because the prices had declined, thus, aggravating the fall in prices (Salisbury 51). The decline in prices in 1929 was very dramatic, leading to the name the Great Crash.
In the 1930s more than 9,000 banks failed (Saint-Etinne 18). A banking panic arose and most people asked for their deposits to be paid back in cash. In such an instance, banks must liquidate loans so as to raise money. This process could lead to the failure of even a previously solvent bank. Nonetheless, since most of the deposits were not insured, most people lost their savings. As for the surviving banks that were not sure of the economic situation and worried about their own survival, they lost interest in creating new loans. The last wave of panic was experienced till 1933 and culminated with declaration of the national “bank holiday” by President Franklin on March 6, 1933. The declaration required that all banks had to be closed and only reopened if the government inspectors found them solvent.
Some economists argue that the bank panics were spread as a result of poor US policies that encouraged the establishment of small undiversified banks, as well as the increase in farm debts witnessed in the 1920s (Saint-Etinne 27). The massive farm debt partly arose from high prices of firm inputs and agricultural goods during the First World War. A lot of money was borrowed to improve and purchase land so as to increase production. However, the farmers could not pay back their loans, because of the fall in the prices for their production. Scholars believe that the decline in supply of money had a severe contraction effect on outputs. It depressed business investments and consumer spending in many ways.
The Gold Standard
The Federal Reserve caused or allowed the huge declines in the supply of money in America partly because it wanted to preserve the gold standard (Temin 88). The currency of each country was set in terms of gold and the price was fixed and defended by monetary actions. While the role of the gold standard in limiting, the US monetary policy is debatable, there is no doubt that it was a very significant factor in passing over the American decline to other parts of the world. Imbalances in asset flows and trade gave rise to international gold flows. When the US economy intensively contracted, the tendency of gold to flow towards the US from other countries greatly intensified. This happened because deflation in the US increased the interest in American goods to foreigners, while the America’s demand for foreign goods reduced because of the low income. To counteract the tendency towards foreign gold outflows and an American trade surplus, central banks all over the world raised interest rates.
Fundamentally, to maintain the international gold rush, there needed to be an intensive monetary contraction all over the world to match the one in the US. As a result, there was a decline in prices and output in various countries in the world that also almost matched the US downturn (Temin 91). Additionally, the gold standard reduced the value of the collaterals of banks and made them susceptible to runs. Just like in the US, financial market disruptions and banking panics in other countries depressed prices and output further.
International Lending and Trade
James and Joseph stress about the significance of other international linkages. They argue that lending to Latin America and Germany by foreign countries had greatly expanded in the mid-1920s. On the other hand, lending by the US to other countries fell because of the booming stock market in the country and the high interest rates (James and Joseph 17). The reduction in foreign lending accelerated credit contractions and a decrease in output in borrower nations further. For instance, in Germany, a country that experienced very rapid inflation, momentary authorities hesitated to embark on the expansionary policy to cancel out the economic slowdown, since it might have re-ignited inflation. This is because of the reduced foreign lending that the economies of countries like Brazil, Germany, and Argentina turned down before the United States was hit by the Great Depression.
Other complications arose from the protectionist trade policies that spread all over the world and the implementation of the Smoot-Hawley tariff in 1930. Even though the intension of the Smooth-Hawley tariff was to reduce foreign competition and increase farm income in agricultural goods, other countries followed suit. Romer argues that as much as these policies might have reduced trade, they did not largely cause the depression in major industrial producers (Romer 41). However, she agrees that the protectionist policies contributed to tremendous decline in prices of raw materials in the global market. In the long run, this led to extreme balance-of-payments problems to producers of raw materials like Asia, Africa and Latin America.
Why did the Depression last long?
Before the 1930s, many of the American financial crises occurred for a period of about four years. By 1935, Italy, Japan, Germany, and Great Britain among many other countries had recovered from the economic crunch and their national product had gone back to the 1929 levels. Although other nations like Canada and France suffered from the same economic dump like the United States, the situation in other countries was not very much different from the financial crises that occurred over and over in the world economies (James and Joseph 32). In 1929, the stock market fell drastically, but most Americans assumed that it was just one of the many periodic brief business cycles in the American industrial society. Some economists predicted that things will be better in 1930. Irving Fisher, one of the great economists in America, forecasted that the worst of the recession would have been felt by February 1930. Even the business community was optimistic; very few expected the dramatic changes would last for a decade.
Romer argues that the debilitating economic policies by President Kennedy prolonged the depression. His insurrection of established order was one of the greatest mistakes he made. Without a reasonable debate or a constitutional convention among property holders, not many people expected political operators of New Deal to change the country’s economic system (Romer 81). The author affirms that the regime uncertainty stifled growth and investment, thus, leading to prolonged Great Depression. There are several reasons to support this allegation. First, the Great Depression stood far apart in depth and duration from the second most severe depression to be happen in the US, that of the 1980s. Secondly, because of the unparallel outsourcing of court decision, regulation and business-threatening laws, the hostility of President Kennedy towards investors coupled with the bad character of the administrators and strategists who came up with the New Deal. The political atmosphere discouraged investors from making fresh long-term commitments. Accordingly, investors were uncertain with the progress of the property-rights regime in the years to come, between 1935 and 1941. Countless statements were recorded by historians to that effect. As a matter of fact, the behavior of the investors in the bond market indicated clearly that they had lost confidence in the US market environment.
The Keynesians also expected a reverse in the Great Depression after the war. In contrast, most businesspeople did not expect anything like the depression after the war (Salisbury 102). From 1935 to 1940, private investors did not risk investing huge amounts like they used to do in the 1920s because of the fear of the policies from the President and his close allies who supported the New Deal. Investors only returned in full force after the death of President Kennedy and the retreat of the New Deal.