Great Depression
From Wikipedia, the free encyclopedia.
The Great Depression was a global economic slump that began in 1929 and bottomed in 1933. However, most of the remainder of the 1930s was spent recovering from the contraction, and it would be well after World War II when such indicators as industrial production, share prices and global GDP surpassed their 1929 peaks. The Great Depression can refer to the economic event, but it can also refer to the cultural period, often called simply "The Depression", and to the political response to the economic events.
The "Great Depression" is so named because it is by far the largest sustained decline in industrial production and productivity from the century and a half where economic records have been kept with any regularity, and it reached virtually the entire industrialized world and their trading partners in peripheral nations. It led to massive bank failures, high unemployment, as well as dramatic drops in GDP, industrial production, share prices and virtually every other measure of economic growth.
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Causes of the Great Depression
Economists, historians, and political scientists have posed several theories for the cause, or causes, of the Great Depression with surprisingly little consensus. It remains one of the most studied events of history to economic historians. Major theories that have been proposed include the stock market crash of 1929, collapse of the gold standard, collapse of international trade, federal reserve policy, and many other influences.
The Stock Market Crash of 1929 as a trigger
In the popular imagination the Great Depression was started by the "Crash of 1929". On October 24, 1929 (the day also known as the Black Thursday), share prices on Wall Street collapsed catastrophically, setting off a chain of bankruptcies and defaults that quickly spread overseas. The events in the United States were the final shock in a worldwide depression, which put hundreds of millions out of work across the capitalist world throughout the 1930s. In truth economic instability had been growing for some time, however, the impact of the Crash of '29 was notable because the Wall Street was where the wealthy of Europe had increasingly banked their gains. The Crash would dramatically reduce the total percentage of wealth held by the very top of the economic scale, and would create financial difficulties for many of them.
The market crash in the U.S. was the final straw for the already shaky world economy. There had been a series of financial crisis points through the 1920's including Germany suffering from hyperinflation, and turbulence associated with Britain attempting to re-establish the gold standard on a pre-war price basis. Many of the Allied victors of World War I were having serious problems paying off huge war debts, which had lead to loan programs from the United States. In the late 1920s, the U.S. economy at first seemed immune to the mounting troubles, running a huge balance of trade surplus, but in 1930, what seemed like a cyclical down turn in the economy turned into a massive economic crisis.
One theory according to contemporary economists such as Peter Temin, as well as observers at the time such as John Maynard Keynes, is that international finance never recovered from the strains of World War I. After the world war there had been a rapid increase in industrialization, as well as sharp cuts in armaments by the major powers, which caused a dramatic increase in productive capacity, particularly outside Europe, without a corresponding increase in sustained demand. Fixed exchange rates and free convertibility gave way to a compromised gold standard that lacked the stability to rebuild world trade. According to this view, the major problem was that the world financial system did not have the ability to increase aggregate demand as fast as supply was increasing. There was an "over investment" in the late 1920's, which lead to a financial bubble that finally came crashing down into a vicious circle of deflation.
In 1929 the world's most prosperous nation was the United States. But despite the confidence in the United States and the apparent economic well-being in other countries, the world economy was in an unhealthy state. One by one, the pillars of the prewar economic system—multilateral trade, the gold standard, and the interchangeability of currencies—began to crumble.
The UK had returned to the gold standard in 1925 but had spent the previous five years managing the gold price down to its pre-war level. This forced a sharp deflation across the economy of the UK and the many other nations that used the Pound Sterling as their national unit of account.
The U.S. economy had been showing some signs of distress for months before October 1929. Commodity prices had been falling worldwide since 1926, reducing the capacity of exporters in the peripheral, undeveloped economies of Latin America, Asia, and Africa to buy products from the core industrial countries such as the United States and the United Kingdom. Business inventories were three times as large as they had been a year before (an indication that the public was not buying products as rapidly as in the past); and other indicators of economic health—freight carloads, industrial production, wholesale prices—were slipping downward.
A maldistribution of purchasing power
Another theory holds that the fundamental maldistribution of purchasing power, the greatly unequal distribution of wealth throughout the 1920s, caused the Great Depression. According to this view wages increased at a rate that was a fraction of the rate at which productivity increased. As production costs fell quickly, wages rose slowly, and prices remained constant, the bulk benefit of the increased productivity went into profits. As industrial and agricultural production increased, the proportion of the profits going to farmers, factory workers, and other potential consumers was far too small to create a market for goods that they were producing. Even in 1929, after nearly a decade of economic growth, more than half the families in America lived on the edge or below the subsistence level—too poor to share in the great consumer boom of the 1920s, too poor to buy the cars and houses and other goods the industrial economy was producing, too poor in many cases to buy even the adequate food and shelter for themselves. As long as corporations had continued to expand their capital facilities (their factories, warehouses, heavy equipment, and other investments), the economy had flourished. Under pressure from the Coolidge administration and the business, the Federal Reserve Board kept the rediscount rate low, encouraging excessive investment. By the end of the 1920s, however, capital investments had created more plant space than could be profitably used, and factories were producing more goods than consumers could purchase.
An increase in margin buying, the act of borrowing money from lenders in order to buy stocks, helped many people invest in the roaring stock market of the 1920s. When the stock market began to decline, the lenders panicked and demanded their money back. This increased the sales of stocks to pay off the loans, but many people remained in debt and the lenders could not get their money back.
The Federal Reserve and the Money Supply
Another theory of the Great Depression, forwarded most notably by economists Milton Friedman and Anna Schwartz, involves the quantity theory of money. According to this theory, most of the depression's severity was caused by poor decision-making at the Federal Reserve.
For the first four years of the Depression the Federal Reserve Board contracted the money supply at a time when Friedman says they should have been expanding it. Note Friedman and Schwartz:
- "From the cyclical peak in August 1929 to a cyclical trough in March 1933, the stock of money fell by over a third."
The result was what Friedman calls the "Great Contraction" — a period of falling income, prices, and employment caused by the choking effects of a restricted money supply. A corrollary of this theory rejects the Gold Standard theory of the depression. It is a notable development because it implies that the depression's severity was caused by the Federal Reserve's mismangement of the economy, not the absence of management. This theory is popular among the Monetarist school of economics. Many give credence to Friedman's theory because the theory has robustly explained most subsequent U.S. recessions and inflations.
A lack of diversification
Another theory attributes the Depression to a serious lack of diversification in the American economy of the 1920s. Prosperity had been excessively dependent on a few basic industries, notably construction and automobiles; in the late 1920s, those industries began to decline. Between 1926 and 1929, expenditures on construction fell from $11 billion to under $9 billion. Automobile sales began to decline somewhat later, but in the first nine months of 1929 they declined by more than one third. Once these two crucial industries began to weaken, there was not enough strength in the other sectors of the economy to take up the slack. Even while the automotive industry was thriving in the 1920s, some industries, agriculture in particular, were declining steadily. While the Ford Motor Company was reporting record assets, farm prices plummeted, and the price of food fell precipitously.
Postwar deflationary pressures
The Gold Standard theory of the Depression attributes it to postwar deflationary policies. During World War I many European nations abandoned the gold standard, forced by the enormous costs of the war. This resulted in inflation, because it was not matched with rationing and other forms of forced savings. The view of economic orthodoxy at the time was that the quantity of money determined inflation, and therefore the cure to inflation was to reduce the amount of circulating medium. Because of the huge reparations that Germany had to pay France, Germany began a credit fueled period of growth, in order to export, to sell enough abroad to gain gold to pay back reparations. The United States, as the world's gold sink, loaned money to Germany to industrialize, which was then the basis for Germany paying back France, and France paying back loans to the United Kingdom and United States. This arrangement was codified in the Dawes Plan.
This had a number of economic consequences in its own right, however what is of particular relevance is that following the war most nations returned to the gold standard at the pre-war gold price, in part, because those who had loaned in nominal amounts hoped to recovery the same value in gold that they had lent, and in part because the prevailing opinion at the time was that deflation was not a danger, while inflation, and particularly the hyper-inflation experienced by Weimar Germany were unbearable dangers. Monetary policy was in effect put into a deflationary setting that would over the next decade slowly grind away at the health of many European economies. While the Banking Act of 1925 created currency countrols and exchange restrictions, it set the new price of the Pound Sterling at parity with the pre-war price. At the time this was criticized by Keynes and others, who argued that in so doing, they were forcing a revaluation of wages without any tendency to equilibrium. Keynes criticism of Churchill's form of the return to the gold standard implicitly compared it to the consequences of the Versailles treaty.
Deflation's impact is particularly hard on sectors of the economy that are in debt, or that use regular loans to finance activity, such as agriculture. Deflation erodes the price of commodities while increasing the real value of debt.
But the deflationary pressures — the industrialization of the United States, the spread of internal combustion, the return to gold, the rapid expansion of German productive capacity — do not account for the severity of the drop in business after 1930 under most models.
The credit structure
Farmers, already deeply in debt, saw farm prices plummet in the late 1920s, their implicit real interest rates on loans skyrocket; their land was already mortgaged, and crop prices were too low to allow them to pay off what they owed. Small banks, especially those tied to the agricultural economy, were in constant crisis in the 1920s as their customers defaulted on loans due to the sudden rise in real interest rates; there was a steady stream of failures among these smaller banks throughout the decade.
Although most American bankers in this era were staunchly conservative, some of the nation's largest banks were failing to maintain adequate reserves and were investing recklessly in the stock market or making unwise loans. In other words, the banking system was not well prepared to absorb the shock of a major recession. The banking system as a whole, moreover, was only very loosely regulated by the Federal Reserve System at this time.
The breakdown of international trade
Another factor contributing to the Great Depression was America's position in international trade. Protectionist impulses would drive nations to protect domestic production against competition from foreign imports by erecting high tariff walls. The Hawley-Smoot Tariff Act of June 1930 raised U.S. tariffs to unprecedented levels and ignited a worldwide tariff war with other countries adopting retaliatory trade restrictions of their own. Smoot-Hawley practically closed U.S. borders and, with retaliatory tariffs from U.S. trading partners, caused the immediate collapse of the most important export industry, American agriculture.
One theory posits that the Smoot-Hawley tariff's negative effects on agriculture was especially harmful because it caused farmers to default on their loans. This event may have worsened or even caused the ensuing bank runs in the midwest and west that caused the collapse of the banking system.
Prior to the Great Depression, a petition signed by over 1000 economists was presented to the U.S. government warning that the Hawley-Smoot Tariff Act would bring disastrous economic repercussions, however, this did not stop the act from being signed into law.
Beginning late in the 1920s, European demand for U.S. goods began to decline. That was partly because European industry and agriculture were becoming more productive, and partly because some European nations (most notably Weimar Germany) were suffering serious financial crises and could not afford to buy goods overseas. However, the central issue causing the destabilization of the European economy in the late 1920s was the international debt structure that had emerged in the aftermath of World War I.
When the war came to an end in 1918, all European nations that had been allied with the United States owed large sums of money to American banks, sums much too large to be repaid out of their shattered treasuries. This is one reason why the Allies had insisted (to the consternation of the perhaps historically vindicated Woodrow Wilson) on demanding reparation payments from Germany and Austria. Reparations, they believed, would provide them with a way to pay off their own debts. But Germany and Austria were themselves in deep economic trouble after the war; they were no more able to pay the reparations than the Allies were able to pay their debts.
The debtor nations put strong pressure on the United States in the 1920s to forgive the debts, or at least reduce them. The American government refused. Instead, U.S. banks began making large loans to the nations of Europe. Thus debts (and reparations) were being paid only by augmenting old debts and piling up new ones. In the late 1920s, and particularly after the American economy began to weaken after 1929, the European nations found it much more difficult to borrow money from the United States. At the same time, high U.S. tariffs were making it much more difficult for them to sell their goods in U.S. markets. Without any source of revenues from foreign exchange with which to repay their loans, they began to default.
The high tariff walls critically impeded the payment of war debts. As a result of high U.S. tariffs, only a sort of cycle kept the reparations and war-debt payments going. During the 1920s the former allies paid the war-debt installments to the United States chiefly with funds obtained from German reparations payments, and Germany was able to make those payments only because of large private loans from the United States and Britain. Similarly, U.S. investments abroad provided the dollars, which alone made it possible for foreign nations to buy U.S. exports.
By 1931 the world was reeling from the worst depression of all time, and the entire structure of reparations and war debts collapsed.
In the scramble for liquidity that followed the Great Crash, funds flowed back from Europe to America and Europe's fragile economies crumbled.
Responses
The Wall Street crash had ushered in a world-wide financial crisis. In the United States between 1929 and 1933 unemployment soared from approximately 3 percent to 25 percent, while manufacturing output declined by one-third. Governments worldwide sought economic recovery by adopting restrictive autarkic policies (high tariffs, import quotas, and barter agreements) and by experimenting with new plans for their internal economies.
The economic crises due to the depression were a terrible epidemic throughout the United States and many parts of the world. Consumers reduced their purchases of luxury cars, clothes, and many businesses cut production. Big businesses such as General Motors saw their sales drop by 50% in the late 1920s and the early 1930s. This caused businesses to lay off thousands of workers.
When the farm prices fell, small farmers went bankrupt and lost their land. By June of 1932, the American economy had fallen by about 55% of the work force. The Government tried to restore prosperity by spending on welfare and public works.
After the stock market collapse, the New York banks became frightened and called in their loans to Germany and Austria. However, without the American money, Germans had to stop paying reparations to France and Britain. Of course, this was a chain reaction and they could not repay their war loans to America. Therefore, the depression had spread to Europe. All governments were forced to cancel both reparations payments and war loans.
The United States government tried to protect domestic industries from foreign competition by imposing the highest import duty in American history. In retaliation, other countries raised their tariffs on imports of American goods. As a result, global industrial production declined by 36% between 1929 and 1932, while world trade dropped by a breathtaking 62%.
In 1932, the United States had elected President Franklin D. Roosevelt. He proposed the "New Deal", a platform of government programs to stimulate and revitalize the economy. The British and French governments also intervened in their economies and escaped the worst of the depression. Moreover, the Soviet Union put in the five-year plans.
Observers throughout the world saw in the massive program of economic planning and state ownership of the Soviet Union what appeared to be a depression-proof economic system and a solution to the crisis in capitalism.
In Germany unemployment increased drastically, fueling widespread disillusionment and anger. The institutions of the Weimar Republic, which had already been standing on shaky ground, started cracking in the years from 1930 to 1932, while Chancellor and finance expert Heinrich Brüning was trying to fix the economy by drastically cutting state spending. At the time, the NSDAP gained much popularity, winning the two general elections in 1932, which eventually led to the appointment of Adolf Hitler as Chancellor on January 30, 1933. (See Weimar Republic for details.) In Nazi Germany economic recovery was pursued through rearmament, conscription, and public works programs. In Mussolini's Italy the economic controls of his corporate state were tightened.
In the United Kingdom, the Labour government of Ramsay MacDonald, and later the Conservative-dominated "National Government" responded to the depression by imposing tariffs on all imports except those of the British Empire (which arguably worsened the global situation), by cutting public spending, and by abandoning the Gold Standard which reduced the cost of British exports. (see Great Depression in the United Kingdom).
In the United States, President Herbert Hoover made efforts to control the situation. However, hindsight shows that at first, he gravely underestimated the severity of the crisis, (even announcing to U.S. Congress on December 3, 1929 that the worst effects of the recent stock market crash were behind them and that the U.S. public had regained faith in the economy). Having realized his mistake, Hoover went before Congress again on December 2, 1930 to ask for a $150 million public works program to help generate jobs. However, one of the major problems was that with deflation, the currency that you kept in your pocket could buy more goods as prices went down. The other was that there had been no federal oversight of the stock market or other investment markets, and with the collapse, many stock and investment schemes were found to be either insolvent, or outright frauds. Unfortunately, many banks had invested in these schemes, and this may have precipitated a collapse of the banking system in 1932; Milton Friedman's monetary theories suggest that the inexperience of the newly-created Federal Reserve in managing the money supply exacerbated the problem. With the banking system in shambles, and people holding on to whatever currency that they had, there was minimal cash available for any activities that would cause positive change.
The response of the Hoover administration helped little; instead of increasing the money supply, the Hoover administration did the exact opposite and raised interest rates, falsely believing that inflation was the real danger. Many in the Hoover administration believed that as wages fell, the cost of production would drop, and as a result, production would pick up again, and the depression would be self-correcting. Nobody at that time understood the effects of a calamitous drop in the money supply. For this reason, they saw no need for the government to intervene in the economy, a policy which proved disastrous.
Like their counterparts abroad, many Americans were disillusioned with their system of government, believing that Hoover's policies had driven the country to ruin. (Shantytowns populated by unemployed people at the time were often dubbed Hoovervilles to highlight the President's fading popularity). During this period, several alternative and fringe political movements saw a considerable increase in membership. In particular, a number of high-profile figures embraced the ideals of Communism, although this would subsequently be used against them during the Red Scare of the 1950s. Radio speakers such as Father Charles Coughlin saw their listening audiences swell into the millions, as they sought for (and often found) easy scapegoats to blame the country's woes upon.
Upon accepting Democratic nomination for president (July 2, 1932), Roosevelt promised "a new deal for the American people", a phrase that has endured as a label for his administration and its many domestic achievements.
Effects of Great Depression on Asia
Asia was also hit by the Great Depression due to its dependence on trade of rubber and tin with the West. Being the biggest buyers of rubber and tin (for the automobile industry), trade sharply fell for Asia after America and Europe bought less of these goods. Companies in Asia had much less profit than before and had to dismiss some workers.
Many workers were dismissed so as to keep the company going and the rest had their pay reduced. Many people had to depend on the aid of their friends or relatives to find a job.
Life during the Depression
In the so-called Dust Bowl, a massive area of the great plains consisting mainly of Kansas, Oklahoma, and parts of Texas, people found themselves unable to make a living. On top of the economic crisis, the earth withered and blew away in a series of massive dust storms. For a farming people this was disastrous, and these migrants were led westward by advertisements for work put out by agribusiness in western states such as California. The migrants came to be called Okies, Arkies, and other derogatory names as they flooded the labor supply of the agricultural fields, driving down wages and increasing competition for jobs in a place that couldn't afford it. This story was dramatized in the famous novels The Grapes of Wrath and Of Mice and Men by John Steinbeck.
International
Many other nations, although not all, experienced a similar decline, though the severity and timing differed from country to country. For example, Britain hit its trough in the third quarter of 1932, while France did not reach its low point until April of 1937.
End of the Great Depression
For details, see the main New Deal article.
It was not until the U.S. entered World War II that Roosevelt's ideas for massive public expenditures and deficit spending truly began to bear fruit. Roosevelt's administration, of course, had little choice but to increase expenditures, given the war effort. Even given the special circumstances of war mobilization, New Deal policies seemed to work exactly as predicted, winning over many Republicans, who had been the New Deal's greatest opponents. When the Great Depression was brought to an end by the Second World War, it was obvious that the turnaround had been caused primarily by the reinforcement of business through government expenditure.
New Deal programs sought to stimulate demand and provide work and relief for the impoverished through increased government spending: the theories behind the New Deal were backed up later by the writings of British economist John Maynard Keynes. In 1929 federal expenditures constituted only 3 percent of the GDP. Between 1933 and 1939, federal expenditure tripled, and Roosevelt's critics accused him of turning America into a socialist state, or even Stalinist state. The primary purpose of the New Deal was to prevent the economy and banking system from going into free fall, to provide effective relief until larger economic forces would end the slump, and to prevent those factors which had exacerbated the slump. The New Deal was both a program of national recovery and of reform. An interesting insight into what motivated Roosevelt came from the transition from the Hoover administration — both men agreed that it was a global maladjustment of prices, debts and production that was causing the slump. The disagreement came over whether the US government should act first to try and negotiate an end to the root causes internationally, which was Hoover's view, or act for domestic recovery and reform until the international situation could be resolved, which was FDR's view.
The New Deal was rooted in new ideas, but also in economic orthodoxy of balanced budgets, and restraint of federal power, it was bigger and broader government than ever before, but it was not as big as government would later become: spending on the New Deal was far smaller than on the war effort. In short, federal expenditures went from 3 percent of the GDP in 1929 to about a third in 1945. The big surprise was just how productive America became: spending financially cured the depression. Between 1939 and 1944 (the peak of wartime production), the nation's output more than doubled. Consequently, unemployment plummeted—from 19.0 percent in 1938 to 1.2 percent in 1944 as the labor force grew by ten million. The war economy was not so much a triumph of free enterprise as the result of government/business sectionalism, of the Federal government bankrolling business. It was World War II which finally provided the United States Federal Government with the ability to inject enough demand stimulus to end the Depresion, and resolve the global monetary crisis by the imposition of the Bretton Woods system.
The Great Depression was not the longest depression on record, that title being held by the Long Depression of the late nineteenth century, nor was it the sharpest contraction, the one after the First World War being a deeper drop. It has commonly been described as the "deepest" depression in history because it represented the greatest fall from the general trendline of growth.
Films
- The Grapes of Wrath , Director: John Ford, 1940
See also
External links
- American Economic Policy from the Great Depression to to NAFTA (http://www.globalpolitician.com/articles.asp?ID=85)
- America's Great Depression — an "Austrian" interpretation by Murray Rothbard (http://www.mises.org/rothbard/agd.pdf)
- The Causes of the 1929–33 Great Collapse: A Marxian Interpretation, by James Devine (http://bellarmine.lmu.edu/~jdevine/depr/D0.html)
- Keynes and Friedman on the Great Depression (http://casenet.thomsonlearning.com/casenet/abstracts/keynesdepression.html)
- Theories on the Great Depression (http://www.southerndomains.com/SouthernBanks/p5.htm)
- The Economics of the Great Depression (http://www.upjohninst.org/publications/ch1/wheelerch1.pdf)
- About.com: 1929 Stock Market Crash (http://mutualfunds.about.com/cs/1929marketcrash/index.htm)
- The Great Depression (ingrimayne.saintjoe.edu) (http://ingrimayne.saintjoe.edu/econ/EconomicCatastrophe/GreatDepression.html)
- The Dirty Thirties (http://www.mccord-museum.qc.ca/en/keys/webtours/GE_P4_1_EN.html) — Images of the Great Depression in Canada
