In the wake of the 1920s, emerging industries and other new methods of production led to prosperity and economic boom in America. An increased number people invested in the stock market than before leading to the hiking of average prices of stocks by 40%. Buying on credit was rather disastrous at this was a season of great economic boom. On average, people’s salaries and wages stayed the same level even as prices for other commodities. Many U.S citizens invested on the stock market, anticipating to make huge and quick profit.
This great prosperity came to a sudden halt in October 1929. As this was happening, people began to fear that the boom was going to end, many stock markets and money markets crashed, the economy was on the verge of collapsing and the United States ushered in a long depression. Unlike many other events, The Great Depression of the 1930s remains one of the most critical economic event in the American history. It caused enormous turmoil for multitudes of people as many firms and other enterprises failed and were operating below the full employment mark.
The Great Depression
Depression is a period in the economy whereby employment and the living conditions of the people become deplorable and wanting. Here, we will try to answer the much-asked question. What caused the worldwide collapse in aggregate demand in the late 1920s and early 1930s?.Later on, I will address an equally important concern about; why did the Great Depression last so long? Normally, the economy has an inbuilt mechanism of stabilization whereby the wages and prices adjust automatically due to changes in demand commonly referred to as ‘the forces of demand and supply’. This economic event was characterized by sharp decline in both output and prices. Unemployment increased to 25%, the government became dysfunctional, and the people were filled with despair and disbelief.
The Great Depression was the most catastrophic of all times. The boom in the building industry that began in late 1918 had doubtlessly helped the economy out of the slump of 1921. Initially it started as a slow slide in construction between 1925 and1927 soured in 1928. Agricultural sector too was not spared either. The situation worsened even further due to the uneven distribution of income amongst households. Both small-scale and large-scale farmers struggled throughout the decade with the constantly declining food prices at the world market. Manufacturing and processing output reduced by 35% during the first year of the Great Depression, which saw a panic in the banking sector and eventually a decline in the money supply.
The Banking Crisis
The devastating effect of the stock market collapse came in the wake of the great depression. The economy was so shaky and unstable because of the bank failures in America. Many banks and other financial institutions were not ready to absorb the shocks of the major recession witnessed at that time. Most economists did not agree with the Federal Reserve Bank being the lender of last resort. It failed too by not expanding the money supply that was expected of it.
The elite class felt that the government which was in place then had failed to take prudent and stern measures to uphold stability in the banking industry and curb the people’s fears about future uncertainties in the economy. Due to poor management, most people believed that this was the reason as to why the banks were not performing. Any rumor that the financial institutions were in trouble, customers could be in hurry to withdraw their money before the banks shut down. As people thought that the situation was improving, a major bank in Vienna Austria failed early in 1931.
There was panic all over Europe which lead to the closure of many German Banks. By 1933, close to four thousand banks that contained in excess of $3.5billion in deposits had suspended their operations. By the time the then American President Roosevelt took office in 1933, the banking system had halted their operations and succumbed to the panic that was going round. He made an announcement commissioning nationwide holidays beginning March 6th, 1933. Banks across the United States remained closed for over a week.
The stock Market Crash
During the last few days of the 1929, there was a break in the stock and capital markets. This was reported by the New York Times index of 25 industrial stocks. Stocks were on the decline due to uncertainties about the future course of the economy. Due to the continued speculation and the collapse, President Habert Hoover of the Federal Reserve bank and his staff were so much concerned. They raised the discount rates to 6% with an intention of regulating the flow of credit into the stock market.
There were protests all over America both from the media and from individuals. Later in the same year, it became almost unattainable to buy a common stock having risen to a whopping 452 in around 1929. The bank of England and other central banks took similar actions for the same reason. Even in the next decade of the 1930’s, share prices remained exceptionally high as were in the 1926 surge. Instantaneous losses of direct wealth, pessimism, psychological trauma, decline of consumer durables were witnessed.
International debt
At the end of the World War II, American banks were hugely indebted by a number of European banks. These respective countries were unable to pay their high loans. The American government wasn’t ready to lower the huge loans or even write off the debts. American economy being the major source of funds to the European countries was on the downfall and as a result there was an uphill by countries to borrow money from the same source. Tactically, America raised their lending rates and tariffs with an intention that the European countries do not get any benefit out of selling their goods in the American market. Consequently, the countries defaulted on the loan repayment.
Growing inequality of Income
Adam Smith the great economist and the father of economics noted that there is no society that can be fruitful, of which the majority of the people are poor and miserable. Though many economists have cited the crash of stock markets and the bank failures as the major causes of the great depression, a steady growth in the Income inequality in the 1920’s cannot be ignored either. The affluent, faced with uncertainties about the future economic conditions and the crumpling of the banking systems are likely to cut on their daily spending. This has the effect of accumulating wealth in a few hands. This major economic meltdown of the 1920’s could have been contained had the progressive income taxation been operational.
Gold Standard
As per the opinion of many economists, the Federal Reserve Bank failed on many fronts. There was pressure for some policies to be put in place that will foresee a sudden decline of the supply of money in order to maintain the standards of gold. In the gold standards, each member states was required to set a given amount of its currency in form of gold and review its monetary policy in that the gold price was kept constant. Trade imbalances arose as a result and this gave rise to increased demand for the American stocks and bonds internationally leading to inflows of gold at the time. As time went by, the American economy began to shrink drastically; so many countries were now willing to trade hence the flow of gold into the U.S. became inevitable. The American goods because more desirable to the outside world due to deflation.
World War One
When the World War I broke out in 1914, nobody expected that it would go on for the next four years. The war caused severe destruction of industries, infrastructural facilities like transport, and communications facilities. The war undermined the economic and financial stability of the U.S. in particular. The real exchange rate of almost all countries became so volatile and even after the war in 1918, it became so hard to revert to the original levels. The foundations of the international monetary systems were compromised in the process. After world war one that took place between 1914 and 1918, many European countries struggled to pay their war debts and other reparations. This caused economic difficulties in many other states of America.
Production versus consumption
There were too much investment in the industry capacity due to boom that was witnessed after World War I. There was little or even no investment in wages and earnings. This meant that industries produced more than what the people could afford and what they actually demanded. Due to the fears of increased economic hardships, the rate at which the people purchased goods deteriorated significantly.
Drought conditions
There was prolonged drought at the start of the 1930s. Low production was experienced which in turn negatively affected their living conditions and their capacity to take up loans became so limited. They could hardly pay their loans and other arrears as per the government. They could hardly afford to pay mortgage on their farm and eventually were forced to rent their land or even move. Since many farmers both small and large scale solely depended on returns from their produce hence were unable to go back to their farms in the next planting season.
Many farm laborers were rendered jobless leading to a slump in the Gross Domestic Product of America. Prices of cotton and textile, which were the main cash crop in the North Central of America, fall drastically. Balance of Trade (BoT) which had been growing over the years on a positive scale turned negative increasing the deficit.
International trade
In the 1930’s, the united states of America raised import tariffs up to almost 50% with a view of raising the demand for domestically produced goods. Contrary to the said motive, unemployment was created in the trading partners of America. The countries retaliated by raising their tariffs too. Coupled with the lack of demand for the U.S goods because of unemployment abroad, it in turn led to increased unemployment in America.
American economic policy with Europe
As businesses and other enterprises began falling in the 1930, the government created a policy commonly known as ‘the Smooth-Hawley Tariff to try and help in protecting the American local industries. The trade between America and her trading partners was negatively affected due to high duties that were levied on imported goods because of economic retaliation.
Why did the Great Depression last so long?
In addition, the Great Depression persisted because most economists who judged the economy basing their argument in the growth rate of the Gross Domestic Product (GDP) and on unemployment changes. Most of the economists thought that the increasing growth in output and the increasing number in unemployment made them make an assumption that they economy was on the right track and this was never the case. Unemployment cannot be used as an indicator to measure the recovery in the economy. It does not show how much work was done, an hour worked per worker or the job is growing, and the most important some of the individuals leave the labor force in the long run.
Moreover, the economists of the time used output growth to measure the recovery of the economy and this required benchmark. Theoretical and empirical benchmarks only show that the economy was growing too fast than before. All the recoveries in output should have focused on the growth of hours worked instead of productivity. Since the American economists like the Keynesians concentrated on the short run factors forgetting that the depression was to last for long. Instead, they could have listened the Classicals view and employ long run factors to fix the recovery.
Summary
The Great Depression pushed the American people into an economic downfall that had never been witnessed in the entire American history before. This economic event has often been pointed out by a number of economists as one of the most severe economic event in America over the decades. It took place between 1929 and 1933. The banking crisis of the late 1920s, the stock market crash, growing inequality, extended drought, World War I, Gold Standards, disparities between consumption and production, international debt and American economic policy with Europe were some of the reasons that were being cited by most economist to have caused the Great Depression.
Many Americans were of the view that President Franklin D. Roosevelt’s new economic policy was one of the possible responses to the local elite class who were mainly capitalists. The deal, which was reached by the President and his staff radically changed the way the Americans related with their government. He recommended the establishment of a reconstruction finance corporation, expansion of government aid to federal land banks, reformation of bankruptcy laws, tightening of immigration laws and the state to be given a grant of direct loan of over 300million U.S Dollars for relief purposes. Also the supply of money grew rapidly in the 1930s because of uncontrolled gold inflow into America. Although this gold inflow into America was due to political developments in Europe, the largest inflow happened immediately following the revaluation of gold commissioned by President Roosevelt.
Work Cited
Bardo, Michael D., Christopher J. Erceg, and Charles L. Evans.“Money, Sticky Wages, and the Great Depression.”American Economic Review 90 (200): 1447-1463.
Mathews layth. “What caused the great depression of the 1930’s?” Internet.http://www.shambhala.org.2002. Print.
Tanner, Neal. “The Easy Life of the ‘20’s contributed to The Great Depression.” Overview: The Great Depression. Internet.http://www.marist.edu/summerscholars. 2002. Print.
