Causes of The Great Depression
Proposed events leading to the onset of the Great Depression
Mid 1920s: Great Britain, France, Germany, the United States and other nations return to the gold standard after suspension during World War I.
1925: Having returned to the gold standard, Britain tries to damper domestic activity to return the gold standard to its prewar rate. Finding it hard to pay for imports when demand is high, Britain raises its Bank Rate in attempt to attract short-term investment and maintain its gold reserves. This led to continued unemployment and civil unrest, leading to a strike in 1926.
1928: Federal Reserve policy turns contractionary in an effort to combat speculation in the NYSE and to prevent gold ouflows. The Fed raises interest rates, making borrowing more costly, and thus, dampering "speculative" investment. While this policy was unsuccessful in preventing speculation, it did result in tightening the money supply and causing price levels to fall.
Late 1920s: "Popular history regards the capital imports as a necessary offset to Germany's outflow of war reparations payments." (Transmission 89). Germany, however, succeeds in postponing its obligations. As a result, net capital inflow into the Germany economy hovers at 2 percent. Germany's Reichsbank thinks the net inflow to be risky, and attempting to curtail it, sharply reduces the amount of credit available on the German market.
Late 1920s: The contractions in the British, American, and German economies depress the economies of other countries through the gold standard. Depressions in other countries' economies were in part due to reduced demand for imports by Britain, America, and Germany and thus a reduced demand for these countries' exports.
August 1929: According to the National Bureau of Economic Research, the onset of a recession occurred.
The Great Depression: A Timeline
October 29, 1929: The stock market crashes, causing stocks to lose approximately 1/10 of their value. (This day was later termed "Black Tuesday.")
Undeniable Facts
From 1929 to 1933, real output fell by about 30%.
From 1929 to 1933, unemployment rose from about 3% to about 25%.
From 1929 to 1933, the dollar deflated on average 10% per year.
From 1929 to 1933, the money supply fell by about 30%.
To put this in perspective we can look at another deflationary episode in American history.
From 1973 to 1975, real output fell by about 3.4%.
From 1973 to 1975, unemployment rose from around 4% to 9%.
Keynesian vs. Monetarists
Black Thursday - The Great Crash
Banks
In June in 1929 there were 25,300 banks in the U.S. Out of these thouands were mismanaged partly due to a lack of effective regluation. In the six years leading up to 1929, the crash and subsequent depression, on average two banks failed every day. For the six year period ending in 1932, they failed at three or more each day.
The loss of deposits, an estimated 25%, was nothing in comparison to the loss of confidence in the banks of 100%.
Tariffs
1922 1924 Hawley-Smoot
The Gold Standard
In our analysis of the Gold Standard in the U.S. and the World, we will be focusing on 1870's to the beginning of the First World War and from the end of the First World War up until 1936 when some of the last major countries went off.
Before the First World War, the gold standard was a successful means of stabilizing the currency. This is due to, on part, the Bank of England, which since 1694 had let the international system. The Bank of England did this by provided management and incuding cooperation. This made for a stable system because the Bank of England could easily adjust for imbalances in the system.
After the First World War was over the countries that managed to get back on to the gold standard found it very unstable. This was not the gold standard they remembered, the credibility was weakened by the destroyed economies, the financial problems such as large government debt, hyperinflation, and now there was no international leader like there had been for hundreds of years. Speculators attacked currencies like the British Pound by demanding gold for their pounds which lead the the bank collapsing in 1931.
Going back off the gold standard was not so bad. Once off the gold standard, central banks would be able to pursue expansionary policies and combat deflation. If the currency is not dirctly linked to the supply of gold, policy makers are free to increase the money supply. In hindsight we now see that those who got off the gold standard early such as Britain and Scandinavia, recovered sooner. Those who got off later such as France and Belgium, recovered later.
The Dustbowl
First, a background on agriculture. Before and during the First World War, millions upon millions of acres farmland were bought and cultivated to feed the evergrowing demand. America was still very agriculturally based and Europe was at war and demanded agricultural products. Since Europe was more focused on industry compared to the U.S., American farmers could still make a profit at the inflated prices for land and high interest loans.
Later in the 20's, this large surplus of farmland, now no longer needed to support Europe, had trouble staying economically viable. Along with this, the large technological improvements greatly increased the manhour productivity on farms lowering the acreage demand. The shift in style of clothing away from wool and cotton further exacerbated the low demand problem. Unlike the factories, The farmer at the time had no means of price control. This means that the farmer had to sell at the lowest price at auctions but had to buy at the high retail prices. It was at this time the country was making a shift towards industry partly due to the increased demand from war-torn Europe and partly due to the lack of demand for more farms. Along with this, the U.S. government dropped their subsidies on agriculture goods and placed them on industrial goods instead. The Tariffs did not help out the situation either.
When there are high interest rates on loans like during the 1920's and 1930's, only those who have a high risk but high profit expectation will take the loans. This concept born out of the bad monetary policy had disasterous effects both on agriculture and industry. In terms of agriculture, the American farmer who was converting the primarily midwestern grazing land into cash-crop farms was betting that the trade barriers would fall and the government subsidy would remain on agricultural products. Their high risk high potential profit possibility blew up into dust when the cycles of nature and government policies went against them.
What the farmers did was they would remove the protective grass in order to plant crops like wheat thus creating an enormous potential for erosion. In the midwest there have been periodic dry spells every twenty years or so and this occured at a time when there was less grass and trees to protect the ground from wind erosion and from the dirt being lifted off the ground. The productivity dropped drastically as farm ownership dropped by more than 30% during the 30's and productivity per acre dropped more than 10 fold due to the havoc the dust caused to plants.
As an aside, I think it's interesting that despite drastic changed in technology and factory-like farms necessary to be economically competitive, changes in the way of life and the mindset of most Americans, politicians still love the quintessential farmer. The small American farmer who is always struggling to make ends meet is still considered the true American.
Environmental and Economic Collapse in the 1930s
Crash of 1929 vs 2000. Learning From Our Mistakes
There are many similarities leading up to the Crash of '29 and '00. The differences can start to be seen after the crash of '00, when correct policies were implimented.
In the 1920's one cannot point to a single factor as the cause for the crash and subsequent depression. There are the minor factors such as the increase in tariff rates, notably the Hawley-Smoot Tariff of 1930; the declining investment of U.S. funds abroad, and the decrease in loans to brokers. A business cycle downturn due to tight money and would end up being the main driving force. One of the drawbacks of the tight monetary supply was that the demand for credit rose as the supply tightened. This drew more credit into the stock market and away from other less risky options. The tight monetary policy which started increasing in 1928 to control the credit let to speculation would also change the expectations of investors. Once these expectations were changed to pessimism it was like pushing a string; it was very hard to alter the expectations with changes in policy and the continuous bad policy that was enacted made it impossible.
During the "Roaring 20's" there was huge flows of investment capital into the U.S. There were leaps in technology like the radio and farming techniques which spurred many new business and investment opportunities. Had it not been for the instability of banks which from 1923-1929 failed at an alarming rate of 2 per day and had no Fed backup, there would have been even more. In the late 1920's there was a turn from investing in the physical economy: transportation, manufacturing, etc, into investing back into the stock market. The corporations would take their money and re-invest it into the market to support the inflated price. Without the investing into the physical economy there was a growing disparity between the stock price and stock value.
In the "go-go 80's" there was a similar trend of huge investment in the U.S. economy. There were also similar technology leaps like the internet bringing us closer together through mass communication. In the 80's we had banking failures which the Fed helped to cover up and rolled over the unpayable debt. In the 90's corporations chose to go the way of those in the late 20's; they re-invested into the stock market instead of using their available funds to increase the physical economy. This created the "bubble" thathat was similar to that of 1929, it was a facade over the declining physical economy.
Just before both crashes there was a three month rally with soaring prices but many would continue to play the "greater fool" game until they became that fool. In the "greater fool theory" speculators would buy stocks that they knew were overpriced because they guessed that someone else would be willing to buy it for an even more absurd price, that someone else would be an even greater fool. At a point, when expectations change, the buying stops and people begin to panic and sell what they can. This leads others to domino in the same fashion.
When faced with a situation with very high real interest rates or in a position to make higher profits, corporations will naturally invest in the aspects of their business that yield the highest rate of return first and on down from there.. The re-investing in both eras is a natural reflex of the firm, albiet caused by different factors. The lack of investment in the physical economy is just a cost of the risky yet profitable investment. In 1929 when the expected profit was seen to be much lower than previously expected there was a panic. The same is true for 2000 but since the real interest rate was much lower the loss was not as substantial.
After both of the crashes we can start to see some very different actions. The Fed of '29 reduced liquidity, tightened monetary policy, and ignored the Banks cry for help. The Fed of '00 essentially put up a "wall of money" creating easy money, they supported the banks, and enacted expansionary fiscal policy by lowering taxes. To add to the Tariffs In 1930 we also had the Hawley-Smoot Tariff Act which worsened the already highly tariffed foreign trade relations and the productivity of the American firms. After the crash of '29 we had the "natural disaster" of the dust bowl, and after the crash of '00 we had 9/11.
The wall of money and increase in the money supply was not a Fed handout post 2000 crash. This wall of money was actually just a promise to provide liquidity, the Fed only gave confidence, which gave optimism and the expected fall was not as hard as that of 1929 when the pompous economic leaders of the time were thought to be out of touch and disengaged. For example, the Treasury Secretary Andrew Mellon said in 1929, "I see nothing in the present situation that is either menacing or warrants pessimism."
