Type: Economics
Pages: 9 | Words: 2587
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The great depression 1929-1940 ranks as the second severest crisis of the United States with the civil war as the worst.  Though it originated in the States, it had grave effect all over the world. The Depression rapidly spread to other industrialized countries staggering the western world. However, the degree of severity and the time line differed from one nation to another for instance it began in Great Britain in the first quarter of 1930 whilst in Denmark it occurred a whole year later. Also European countries got the brunt more than Japan and countries in Latin America. There was a general drop in government revenue, a considerable decrease in international trade and high rates of unemployment in the world. The unemployment rates by 1933 were 26.3 % in Germany, 23.7 % in Sweden, 14.1 % in Britain, 20.4 % in Belgium, and 28.8 % in Denmark.

Citizens of the United States have never experienced such despair as that felt in the late 1920’s stretching into the 1930’s. Millions of Americans were out of jobs and even lowly jobs had huge lines in waiting. Banks lost most of their investments with the crash of the stock market whilst members of the public in panic rapidly withdrew savings culminating into bankruptcy for almost the whole population. Unfortunately, farmers who to some extent are sheltered from the effects of a depression were hard hit by a relentless famine and consequences of over farming meaning that they could not feed themselves let alone the rest. Majority of the population lived in shantytown they nicknamed “Hoovervilles” in jest of the then president Hebert Hoover whom they blamed for the depression.

October 29th 1929 better known as Black Tuesday when the stock market plummeted officially marked the start of the Great Depression though the American economy had been spiraling down for six months. One may cite the over spending and the social disparities of the “Roaring Twenties” as a cause of the Depression. Though it contributed the immediate primary cause of the Great Depression in the United States was a decline in spending (aggregate demand), leading to a decline in production as manufacturers and merchandisers noticed an unintended rise in inventories.


Causes of the Great Depression

Economic scholars vary in stating the possible causes of the great depression and in where they place emphasis. Despite the placement of the following factors in strength by various scholars, there is a common consensus that they are the major factors that caused and spread the Great Depression in the United States. The actions and non-actions of  Federal Reserve, famine that swept farms better known as “the dust bowl”, protectionist policies and the gold standard, the aftermath of world war one, stock market crash of 1929 and banking failures. Factors are however unique to each country that was affected yet related.

1. World War One

World War 1 struck in Europe in August 1914 when the government of Germany declared war against France and England. From the very start, the United States declared that they would maintain an isolationist policy in the war. During this time, it became the source for the nations in war and the industrial sector rose significantly.  However, the isolationist was a difficult policy to uphold as the war affected U.S. interests as a state and as a populace. In 1915, the policy was tried when German submarines sunk a British ship killing 130 Americans.  The last straw came in 1917 when a German reverted on the Sussex pledge stating that it would not sink anymore. The United States officially joined the war as an ally in the spring of 1917. This timely intervention gave the Allies victory over the Central Powers. The involvement of the US in the war made federal spending to inflate up to thrice the tax revenue.

Citizens enjoyed widespread prosperity in the years after the war despite the labor tensions and racial undertones. The stock market became widely perceived as a way to get rich quickly hence, people used their savings and borrowed heavily to take advantage of the sudden boom. The loose market regulations caused rampant speculations amongst investors who bought stocks at minimal margins. This caused the values stocks to be artificially inflated.  The stock market rose disproportionately to the rest of the economy. The similar false high spirits that caused heavy investment in the stock market were reverted to panic when the stock market started tumbling in the months preceding the fateful black Tuesday. Pure fear drove investors to call massive sell offs that eventually crashed the stock market. In month of October alone, loses totaled to 16 billion dollars. The stock prices declined swiftly by 33% between September and November that year.

As the United States prospered, most of the western world was healing from the effects of the war. The relative prosperity made the U.S. the world’s banker with European countries borrowing heavily to redeem themselves. However, they defaulted on their loans. During this time of recovery, European states minimized their purchase of American goods unlike during the warring period when U.S was the main resource.

This was a particular prime reason for the heavy farm debts, which was compounded by the fall in the value of farmland. Between 1920, the end of the world war and 1929 the year of the crash, the value had decreased by 30%-40%. By 1928, the farmers’ share of national income had plummeted to 9% from 15%.  Agricultural goods had very high prices during the war which made farmers borrow heavily to increase production and maximize on profits. The sudden decline after the war made it impossible from farmers to maintain the loan payments.

2. Federal Reserve

The Federal Reserve as the nation’s Central Bank is one of the most powerful economic institutions in the country. It performs four chief functions that are vital for the stability and performance of the economy. The Federal Reserve has the great function of managing monetary policies in a manner that keeps inflation in check.  Inflation adversely affects the investment and savings sectors, tax revenue and real debt of government. Recent findings also indicate that increase in economic growth is indirectly proportional to inflation.

It manages also the aggregate demand that is driven more by monetary than fiscal policies. In ensuring proper monetary policies, it encourages stability in the economy and financial markets. Interest rates affect sensitive sectors of the economy such as investment and housing. The Federal Reserve has the mandate to sway interest rates by maneuvering reserves. It however has influence over short-term interest rates as monetary policies determine long-term interest rates. Lastly, in order to steady the financial system it acts as the ‘lender-of –last –resort’ in times of unexpected financial shocks and in a financial crisis by filling sudden and sharp rises in reserve and liquidity demand.

In 1928 and 1929, the Federal Reserve deliberately raised interest rates as a counter to the rising stock market. This in turn caused a downturn in the purchase of automobiles and construction leading to a reduction in production. Automobile sales had gone down by a third just in the nine months that precede the crash and construction had declined since 1926 by 2 billion dollars.

Between 1929 and 1933 the money supply of the U.S. declined by 33% because of banking panics. The decline in the money supply caused a decline in consumer and business investment spending. The belief is the Federal Reserve partly allowed the massive declines in American money supply to maintain the gold standard, which was a system where nations set a currency’s value in terms of gold and defended the fixed price with monetary actions. An expansion meant huge gold outflows and subsequent devalue whereas tightening translated into dumping the gold standard just as Britain did.

3. Bank failures and bank panics

Banks are regulated more than other firms are, as their failures are perceived to have more severe effects on the economy than other business firms do. The failure of an individual bank may cause a ripple effect resulting in systemic failures.

Banking panics occur when depositors lose faith in their bank’s solvency and demand their money back in cash. As we know, banks do not hold all their deposits in cash reserves, this sudden cash demand caused hasty liquidation, and even previously, solvent banks began to fail. The panic spread quickly causing a cycle from 1930-1932: the more the people withdrew the more banks failed and the more banks failed the more people withdrew.   At the time, U.S. policies allowed for small banks that lacked diversity. This together with the increasing farm debts caused and propagated the banking panics.

Due to the boom of the roaring twenties, the whole nations was filled with banks. Even small towns had one or two that were giving out loans to hopeful farmers and taking deposits from booming businesses.  In the twenties, an estimate of 70 banks was failing nationally and by the number had multiplied by 10. In the peak of the Great Depression, 1933, 40 billion dollars were lost and approximately 10.000 banks failed. In those days, the policy of deposit insurance was not in action so if a bank failed you lost all your money. Individuals lost their life savings, companies lost most of their investments and lay off workers increasing the unemployment rates, and there was a general sharp drop in consumption.

When Franklin Roosevelt assumed power in 1933, he called for thee closure of all banks and were permitted to reopen once deemed solvent by government inspectors. He marked this by declaring March 6 1933, the “National banks holiday”. However, by then one fifth of banks had failed.

4. The reduction in consumption

Consumption is, or shall be defined to be, the total quantity of goods and services that people in the economy wish to purchase for the purpose of immediate consumption. (Miller)

The Great crash of the stock market created uncertainty of future incomes so consumers drastically reduced business investments and purchase of durable goods. The decline of consumer and firm spending resulted into a decline in the real output of the United States. Though it had been slowly deteriorating prior to this, it drastically plummeted.

This same uncertainty is what caused the panic that culminated in the banking panics. People withdrew large sums of money and kept them as emergency reserves.

5. Protectionism

In 1930, the Smoot Hawley tariff was enacted to protect American farmers from international competition in agricultural production. It increased import duties by about 20% translating into an increase to 47% from 40% for dutiable imports. This policy did not have a direct effect on world trade however, it served to create complications in the world market as other nations followed suit in an attempt to retaliate and to balance the international trade.  Douglas states that

“It created bitterness and resentment abroad. Here was the world’s largest creditor nation, with a substantial trade surplus, restricting the trade of other countries that were trying to pay off their World War I debts. Here was a country that failed to join the League of Nations now undermining that body’s efforts to coordinate a tariff truce among countries to stop any movement toward greater protectionism.” (Irwin D. A., 2009)

There hence was worldwide increase in protectionist policies that reduced levels of world trade and cause sharp declines in the prices of raw materials and primary products in the international market. The third world nations i.e. Africa Asia and Latin America were severely affected, as they are primary producers.

To state these as the only reasons that caused this momentous economic crisis of the 20th century would be a great misconception. These are just some of the major possible causes and must not necessarily fall under the above titles. They are also not separate events but are all interrelated and occurred almost concurrently and propagated each other.

Impact of the depression

It is impossible to ignore the widespread human suffering that was caused by the depression. The feeling of hopelessness was rampant and people generally felt poor. This was not baseless as living standards dropped dangerously within such a short period for instance from 1929 to 1930 the GNP fell by 9.4%, by 8.5% in 1931 and 13.4% in 1932. (Timeline of The Great Depression, 2006) It was hard to find basic goods and wealth was lost in an instant. In order to understand what this meant, in the recession of 1981-1982 GDP declined by a mere 2% whilst in the great depression they fell by 33%. In the peak of the former unemployment was under 10% but it went well over 20% in the depression.

Politically, it served to aggravate tensions in Europe and maintained the rifts established by the world war. It fueled the feelings of nationalism especially the protectionist policies. The global economic crisis at this time and the responses of major nations in part led to the Second World War. Internal politics also became tense for instance in America, the Republican Party was blamed for the depression hence Hebert Hoover did not stand a chance in the next elections. President Franklin Roosevelt was inaugurated with much optimism that he would restore the economy.

The depression caused a great change in the world economy in various ways especially economic policies. It highly influenced the demise of the international gold standard that was replaced by the fixed currency exchange rates later replaced again by the floating rates. The high rates of unemployment -20% of Americans were unemployed by November 1932 (World War 1, 2008)- and the National Labor Relations (Wagner) Act (1935) that promoted collective bargaining saw the rise of both labor unions and expansion of the welfare state. To eliminate possibilities of future banking panics The United States established the Banking Act of 1933 to establish deposit insurance. The Securities and Exchange Commission in 1934 was also established to regulate stock market trading prices.

Economic scholars launched many other macroeconomic policies in light of the effects of the depression. The depression hence changed the outlook of the macroeconomy as a sub-discipline. All the changes that occurred were too effect that the crisis would never repeat itself.

Recovery from the Great Depression in U.S

Just as the depression-impacted nations at different times and in varying degrees, so did nations recover in different ways and at differing times. However, by the end of the decade (1940) most nations had achieved some substantial measure of recovery. The main sources of recovery in the world over were the devaluing of currency, abandonment of the gold standard and monetary expansion. In U.S., the monetary expansion instituted in 1933 had a great impact causing an increase in money supply by nearly 42%.  A great indicator in the United States that monetary expansion stimulated recovery especially by encouraging borrowing was that there was an increment in consumer spending over interest-sensitive items such as automobiles and machinery even before consumer spending on basic services. (Cole & Lee, 2004)

President Franklin Roosevelt did not disappoint the people in his program the New Deal initiated in early 1933. The Works Progress Administration (WPA) initiated new government buildings and contracted the unemployed and the Agricultural Adjustment Administration (AAA) assisted farmers in their debts. Other programs authorized by congresses aimed at generating recovery are The Civilian Conservation Corps, Farm Credit Administration, Federal Insurance Corporation, Federal Emergency Relief Administration, and Tennessee Valley Authority.

All over new policies and stringent measures were adopted which maybe had it not have been for the great depression they would have never been instituted. The great depression altered the structure of the world economy and is in a great part responsible for the international market, as we know it today.

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