Information

Great Depression: Causes and Definition


The Great Depression began with the stock market crash of 1929 and was made worse by the 1930s Dust Bowl. Roosevelt responded to the economic calamity with programs known as the New Deal.


Great Depression: Causes and Definition

However, a stock market crash could cause people to increase their liquidity preference which might lead them to hoard money.

In the August 1990 issue of The Quarterly Journal of Economics, Christine D. Romer writes that "the negative effect of stock market variability is more than strong enough to account for the entire decline in real consumer spending on durables that occurred in late 1929 and 1930."

Hoarding Money

If a country has a gold standard, then hoarding money can make the money supply drop dramatically since a gold standard makes the quantity of money difficult for the government to control.

The Gold Standard

At the time of the Great Depression,America had a 100% gold standard for its money. This meant that all cash was backed by a government promise to redeem it in a specific amount of gold (at the time, one ounce of gold was redeemable for twenty dollars). Because the amount of money circulating in the economy is wholly dependent on the amount of gold available, the money supply is very rigid. If people start to hoard money (see above) the money supply can drop drastically. As noted in the previous section on hoarding, this is not a problem as long as prices and wages drop instantly to reflect the lower amount of money circulating.

The Smoot-Hawley Tariff
The Federal Reserve Board

The Fed was ostensibly created to prevent bank panics and Depressions. Is it possible that the Fedwas actually responsible for the Depression? The answer is a qualified no. The Fed took several actions that, in retrospect, were quite bad. The first thing it did was to inflate the money supply by about 60% during the 1920's. If the Fed had been a little more careful in expanding the money supply, it might have prevented the artificial Stock market boom and subsequent crash. Second, there are indications that the economy was starting to cool off on its own in early 1929, thus making the interest rate hike in TBD completely unnecessary and avoiding the subsequent crash. The third mistake the Fed made was in early 1931. The Fed raised interest rates, exactly the wrong thing to do during a contraction. Ironically, the country's gold stock was increasing at this point all on its own, so doing nothing would have increased the money supply and helped the recovery.

Hall and Ferguson write that:

Hall and Ferguson also write that:

Malinvestment
Sticky Prices/Sticky Wages
Income Inequality

In American Inequality: A Macroeconomic History (1980), by Jeffrey G. Williamson and Peter H. Lindert, it is reported that the period of 1928 through the first three quarters of 1929, using any number of income inequality measures, the U.S. may have experienced "the highest income inequalities in American History" .

In The Great Depression: An International Disaster of Perverse Economic Policies, Hall & Ferguson write that:


What Caused the Great Depression?

Few areas of historical research have provoked such intensive study as the causes of America’s Great Depression—and for good reason. Tens of millions of humans suffered intense misery and despair.

How bad was the Great Depression? The dimensions of the economic catastrophe in America and the rest of the world cannot be captured fully by quantitative data alone, but here are some figures that might help put this economic nightmare into perspective:

  • From 1929–1933, production at the nation’s factories, mines, and utilities fell by more than half.
  • People’s real disposable incomes dropped 28%.
  • Stock prices collapsed to one-tenth of their pre-crash height.
  • The number of unemployed Americans rose from 1.6 million in 1929 to 12.8 million in 1933.
  • At the height of the Depression, one of every four workers was out of a job.

Because of these unspeakable traumas, the Great Depression and its causes have remained at the forefront of economic study and debate. The Great Depression was a complex event, and understanding what happened is no small challenge. In this guide, we aim to give you a clear picture of the key historical figures, policies, and events that caused and extended America’s Great Depression.

We’ll start by breaking down the timeline of how exactly the Depression unfolded, which we’ll break up into into four distinct phases.

The Four Phases of the Great Depression

When you think of the Great Depression, probably the first thing that comes to mind is the massive stock market crash of 1929, when stock prices plummeted spectacularly and investors dumped their stocks as fast as they could. The ensuing panic was memorable indeed, but it was only one aspect of the Depression. In fact, the Depression had four distinct phases:

  1. The government’s “easy money” policies caused an artificial economic boom and a subsequent crash.
  2. President Herbert Hoover’s interventionist policies after the crash suppressed the self-adjusting aspect of the market, thus preventing recovery and prolonging the recession.
  3. After Hoover left office, Franklin Delano Roosevelt’s “New Deal” expanded Hoover’s interventionism into nearly every aspect of the American economy, thus deepening the Depression and extending it ever longer.
  4. Labor laws such as the Wagner Act struck the final blow to the remaining healthy sectors of the economy, dragging the last remaining bulwarks of productivity to their knees.

Each of these phases are marked by distinct events, and each had their own specific causes. Together they produced one common result: business stagnation and unemployment on a scale never before seen in the United States. Let’s examine each phase and its causes in turn.


1. The speculative boom of the 1920s

As anyone who's read "The Great Gatsby" or seen "Chicago" knows, the period popularly called the "Roaring Twenties" preceded the crash. GDP grew at an annual rate of 4.7%, while the jobless rate averaged 3.7%. From 1920 to 1929, total wealth in the U.S. more than doubled, and individual Americans started investing in the market in a big way.

But all was not as roaring as it seemed. Consumer debt increased, and companies over-extended themselves too. Financial institutions became heavily involved in stock market speculation. In some cases, they created securities "subsidiaries" with their own brokers secretly selling their own stocks — what would be a clear conflict of interest today.

Weak regulations had opened the way for a period of wild speculation on stock exchanges. Being "in the market" was the "in" thing, but many investors weren't researching companies and buying based on the fundamentals — they were just gambling that the stock would keep going up.

Even worse, many people bought shares on margin, generally needing just 10% of a stock's price to make a purchase (not realizing they'd be on the hook for the whole amount if the price fell). That, in, turn, inflated prices, with shares selling for more money than justified by their companies' actual earnings.

Still, the stock market stubbornly kept on climbing. That is, until October 1929, when it all came tumbling down.


Causes of the Great Depression

There are many misconceptions about the causes of the Great Depression, especially among historians. The general consensus is that rampant speculation in the stock market and economic mismanagement by Calvin Coolidge caused the Great Depression, but the truth is quite different. The main issue is that when historians get the causes and cures of the Great Depression wrong, and they do so with such confidence that many people believe their misconceptions. This article will discuss the reasons given for the Great Depressions as well as its true causes to set the record straight.

Claim: Rampant speculation in the stock market caused the Great Depression

Whereas there was some speculation within the stock market, if you look at the Dow Jones Industrial Average (DJIA) at the time, you can see the bubble wasn’t as big as has been stated. On December 31, 1928, the DJIA hit 300.00 for the first time, where it was at in June of 1929. On September 3, 1929 it peaked at 381.17, the initial market crash bottomed out on November 13, 1929 at 198.60, but recovered to 294.07 on April 17, 1930. To recap, the speculative bubble started in July 1929, peaked in September, bottomed out in November and recovered by April.

Claim: Investors Buying on Margin caused the Great Depression

Buying on margin is when an investor only puts up a percentage of the purchase price when buying stock. The argument goes that investors who bought on margin couldn’t repay their loans after the crash, which brought the entire economy down. In the 1920s, Margin buyers generally had to front 50% of the stock price, but sometimes they could buy stock for as low as 33% of the value, the margin requirement today is only 25%, and 50% of stock purchases today are bought on margin. Brokers set margin requirements at their highest point in the history of the New York Stock Exchange in 1929. The characterization that margin buying was unique to the 1920s and that there was an uncontrolled orgy of margin buying leading up to the Great Depression is a gross exaggeration. Whereas it is true that some margin buyers went bankrupt, they didn’t single handedly tank the economy. Less than 1% of Americans owned stock at the time, as opposed to today, where over half the population owns stock in one way or another. How could less that 1% of people losing some or all of their wealth destroy the economy? It couldn’t, but greedy rich people always make nice scapegoats.

Claim: Coolidge allowed the federal reserve to over expand the money supply

Some claim that the Federal Reserve pumped all kinds of inflationary cash into the economy and that Coolidge was responsible because he was president. Reality couldn’t be further from the truth! First of all, the president doesn’t control Fed policy, which was especially true back in those days. It really wasn’t until Lyndon Johnson that presidents tried to influence the Fed’s monetary policy. Secondly, the Fed during the 1920s didn’t follow an expansive monetary policy, they actually had an overly tight policy in the 1920s. Austrian economist believe that inflation caused by bad banking processes causes the economy to be thrown out of balance leading to a recession. Austrian economist Murray Rothbard in his book “America’s Great Depression” reinvented the meaning of inflation to fit this scenario. In order to show an increase in monetary policy, he added things that are not actual money in his definition of money to falsely show an expansive monetary policy. Rothbard mistook financial wealth for money by adding in things like life insurance policies into the money supply. The problem is that you cannot spend a life insurance policy unless you cash it in for money first. Many historians have used Rothbard’s false inflation to explain the Great Depression. A better measure would be to look at actual inflation within the terms of Harding and Coolidge. What a dollar would buy in 1921 would only cost 96 cents in 1929. The fact is that not only was there no inflation in the 1920s, there was actually deflation.

Claim: The stock market crash caused the Great Depression

Whereas the stock market crash did set off a recession, it did not cause the Great Depression. If the Federal Reserve and president Herbert Hoover had reacted in the proper manner, there would have been a short, sharp recession, like in 1920-1921, rather than the twelve year Great Depression that was experienced. The economy actually started recovering after November of 1929, but other factors doomed that recovery. After the market crash, unemployment went up to 9%, but it dropped to 6.3% by June of 1930. Stock prices recovered to where they were in July of 1929 by April of 1930. The stock market crash in 1987 was bigger as a percentage of the entire market than the 1929 crash, yet it wasn’t even followed by a recession. The economy has gone through market crashes both before and after the Great Depression without having a similar economic calamity. It wasn’t the initial stock market crash that did in investors, it was the continuous slide into economic calamity that happened after the crash that did them in.

Claim: weakness in the farming sector of the economy caused the Great Depression

The argument here is that since the farming sector performed poorly compared to 1917 to 1920 timeframe, that the depressed farming sector sunk the economy. The problem here is that in order to show a “depressed farming sector”, one has to carefully cherry pick their statistics. From 1917 to 1920 the United States had a farming boom due to World War I, as most of Europe’s farmland had been destroyed during the war and many farmers were sent off to battle. During this time frame American farmers fed Europe. The basic economic theory of supply and demand states that when supply is low, prices will go up. Without European farmers as competition farm prices exploded. One cannot seriously claim that the factors that led to the American farming boom in the late 1910s were a normal state of affairs that could be expected to continue indefinitely. What $100 would buy in agricultural goods in 1912 was worth between $220 to $235 from 1918 to 1920. Once the European farms recovered, the bottom fell out and prices went to $121 in 1921, which was still better than any year before 1917, and prices eventually rose to $142 by 1928. Whereas the farming sector didn’t perform as well as other sectors within the economy, it was no where near as bad as some have made it out to be. By choosing banner years to measure against, one guarantees that any year thereafter would look bad by comparison. The issue in the farming sector was overproduction, which was encouraged under Woodrow Wilson, as farmers were called on to feed Europe. Overproduction was further exasperated by more efficient means of farming, including better fertilizer’s, seeds and equipment. In 1920 farmers started going away from mules and horses replacing them with tractors. Without those working animals, farmers could use the land that they grew feed on for their mules and horses to produce additional crops to sell at market. What needed to happen was that some workers needed to move from the agricultural sector to other portions of the economy.

Some historians blame Coolidge for not signing the McNary-Haugen Farm Relief Act, but this was a dubious law at best. The bill would have forced the federal government to buy all “excess” farm production and then to sell it at a loss on the world market. The act would have had several negative effects had Coolidge passed it:

  • It favored a narrow constituency at the cost of everyone else. It would have raised agriculture prices, helping farmers, but hurting everyone else through higher food prices and higher taxes to pay for the program.
  • It would have caused inflation. Higher prices across the agricultural sector would push prices across several other sectors. Commodities covered by the bill went beyond food and included cotton and tobacco.
  • It would have a negative affect on relations with other countries. Obviously other countries wouldn’t be happy about our dumping of agricultural goods on their markets. The act was morally objectionable as well, as it would have hurt farming sectors across the globe, possibly with devastating affects. This scheme would likely have led to retaliation from other countries.
  • It would have exasperated the issue of overproduction. The government agreeing to buy all “excess production” would inevitably lead to farmers increasing production to get the guaranteed subsidies. Simple economics, with unlimited demand, supply will go up.
  • Once government subsidy programs are enacted, they are very hard to get rid of. Any attempt to do away with the program would be met with strong opposition from the special interest groups that benefit from them.
  • Other beleaguered sectors of the economy would demand similar treatment. If passed, any other industry that was “in trouble” would certainly ask for their own version of the McNary-Haugen bill or to have it extended to them.

Claim: The prosperity of the 1920s was a false prosperity

Some historians contend that the prosperity of the 1920s was all an illusion that only existed in a speculative stock market, but the truth is quite different. The roaring twenties under Warren Harding and Calvin Coolidge saw unprecedented economic growth. From 1921 to 1929 the economy grew at 4.7% per year. Under Coolidge inflation was zero percent and unemployment averaged 3.3%, it is considered “full employment” at a rate of 4.0%. During the 1920s regular people were able to enjoy items that were seen as luxuries in the previous decade. From 1920 to 1930, the percentages of households with the following items increased as follows: Electric lights 35%-68%, indoor plumbing 20%-51%, Central heating 1%-42%, washing machines 8%-24%, Automobile 26%-60% and vacuum cleaner 9%-30%. Average everyday Americans were far better off when Coolidge left office than they were when Harding entered office. By any honest measure, the economic prosperity of the 1920s was real and helped all sectors of American society.

With all of these false claims as to what caused the Great Depression, one might ask, what actually caused the depression. It was caused by a combination of two main factors: bad monetary policy and bad fiscal policy.

How the Federal Reserve caused the Great Depression

The Federal Reserve destroyed the economy in three different ways leading up to and throughout the Great Depression.

  • The Federal Reserve pursued an overly tight monetary policy. Contrary to what many assert, the Federal Reserve pursued a tight monetary policy, especially after the 1929 stock market crash. Because of the Fed’s monetary policy, there was currency deflation from 1921 through 1933, which actually restricted the economy. Most economist generally believe that an optimal inflation rate to be between one and two percent. The reason that economist don’t shoot for an inflation rate of zero percent is that they know that deflation is worse than inflation and that deflation should be avoided even at the cost of adding some inflation into the economy. As the economy grows, the amount of currency within the economy needs to grow at least as fast as economic growth to avoid currency deflation. The problem with currency deflation is that it raises real interest rates, which are the nominal interest rates adjusted for inflation. During the Harding and Coolidge years the economy was so robust and the deflation was small enough, that it’s impact upon the economy was negligible. Once the stock market crashed, the deflation was much more pronounced and the higher real interest rates smothered investments, helping to send the economy into a downward spiral. Even though nominal interest rates were low in 1931 and 1932, real interest rates were a prohibitively high 14% to 16%. From 1929 until 1933, the fed contracted the money supply by 33%, which led to the failure of a third of the countries banks.
  • The Federal Reserve hiked up interest rates. In January of 1928 the Federal Funds rate was 3.5%, by August of 1929 it was at 6.%. Such drastic increases in the federal funds rate are almost always followed by recessions. By almost doubling rates, the Federal Reserve caused the initial economic crash. These interest rates increases also had unintended global economic effects, as foreign central banks were forced to raise interest rates right along with the Federal Reserve. This monetary tightening was instrumental in triggering recessions in other countries.
  • The Federal Reserve failed in its duty as a lender of last resort. The Federal Reserve was created to be a lender of last resort, a duty it had taken away from the commercial bank clearinghouses. The Federal reserve abdicated it duties and sat by and watched as banks failed rather than providing liquidity through loans. Nobel prize winning economist Milton Friedman stated that the Great Depression would not have been a depression had the Federal Reserve not failed in it’s duty. Freidman stated: “If the pre-1914 banking system rather than the Federal Reserve System had been in existence in 1929, the money stock almost certainly would not have undergone a decline comparable to the one that occurred.” Had the Federal Reserve acted properly there would have been no where near the number of bank failures that there were.

How bad fiscal policy caused the Great Depression

Herbert Hoover has been painted by historians as a laissez faire do nothing president. The problem is that Hoover did quite a lot to fix the economy, and with every move the country sank further and further into the depression.

  • Hoover promoted governmental interference in business decisionmaking. A month following the market crash Hoover summoned business leaders to implore them not to cut wages, believing that high wages were a way out of the depression. Hoover missed one important point, wages are a cost of doing business. During the depression prices were failing, so wages should have naturally fallen as well. Businesses honored Hoover’s request not to cut wages, and cut employees instead, leading to mass unemployment.
  • Hoover rejected economic policies that worked in the not too distant past. Hoover rejected Treasury Secretary Andrew Mellon’s suggested “leave-it-alone” approach, and eventually replaced him with the more activist Ogden Mills. Mellon wanted to use the same formula that he used under Warren Harding to fix the 1921 recession: Slashing government spending and letting businesses liquidate unprofitable investments, allowing the market clear itself. Instead Hoover did the exact opposite, increasing spending from $3.1 billion in 1929 ($47.0 billion in 2019 dollars) to $4.7 billion in 1933 ($96.2 billion in 2019 dollars).
  • The Smoot Hawley tariff 1930 On June 17th 1930, Hoover signed the Smoot Hawley tariff, which touched off a trade war against the United States. This was done at a time when the U.S. was actually exporting more goods than it imported, meaning the US needed exports to sustain it’s economy. A petition was signed by 1,028 American economists asking Hoover to veto the legislation. Threats of retaliation began long before the bill was enacted into law in June 1930. U.S. imports decreased 66% from $4.4 billion (1929) to $1.5 billion (1933), and exports decreased 61% from $5.4 billion to $2.1 billion.
  • The Revenue Act of 1932 Hoover passed the biggest tax increase in American history. The top tax rate went from 25% to 63% and the bottom rate went from 1% to 4%. Hoover also lowered personal and dependent deductions as well as creating all types of new excise taxes. The tax increases of 1932 had several bad affects. By increasing excise taxes Hoover raised the prices of those goods, thus lowering sales. Basic economics: Supply and Demand. Higher prices reduce demand meaning less supply is needed, leading companies to cut back due to the market forces. The income tax increases discouraged investments, by reducing the reward one would get from investing because the government takes a higher percentage of profits. Basic economics states that investments are based on risk versus reward. Remove the reward and people won’t take the risk. The check tax helped lead to bank runs as depositors took there money out of banks and decided to pay cash to avoid paying the tax.

As can be seen, the true causes of the Great Depression are far different than those laid out in most history books. Until the Great Depression is truly understood, governments and central banks will continue to act in manners that cause future recessions and that inhibit economic recoveries. Voters will also support policies that go against their best interests, because they don’t know any better believing what the history books told them.


Depression medications

Sometimes, symptoms of depression or mania are a side effect of certain drugs, such as steroids or blood pressure medication. Be sure to tell your doctor or therapist what medications you take and when your symptoms began. A professional can help sort out whether a new medication, a change in dosage, or interactions with other drugs or substances might be affecting your mood.

Keep in mind the following regarding drugs that may affect depression and mood:

  • Researchers disagree about whether a few of these drugs — such as birth control pills or propranolol — affect mood enough to be a significant factor.
  • Most people who take the medications listed will not experience mood changes, although having a family or personal history of depression may make you more vulnerable to such a change.
  • Some of the drugs cause symptoms like malaise (a general feeling of being ill or uncomfortable) or appetite loss that may be mistaken for depression.
  • Even if you are taking one of these drugs, your depression may spring from other sources.

Reading Understanding Depression and sharing it with those closest to you might help improve your life — or the life of someone close to you! Read more »


Overview: Causes of the Great Depression

The crash of the New York Stock Exchange on October 29, 1929, signaled the start of the Great Depression, the worst economic crisis in U.S. history. This period would last until 1941, when the United States began preparations to enter World War II (1939–45). When the stock market began to spiral downward, many looked on in disbelief. However, others recognized that the plummeting prices were a confirmation of severe economic problems long in the making. For much of the 1920s the United States seemed prosperous. Many Americans were employed, and goods such as automobiles, appliances, and furniture flowed out of factories. Yet an undercurrent of unhealthy factors ran through the American economy—factors that all came together and surfaced in late 1929.

During the 1920s there was no national economic planning or any significant watchdog agency to monitor the U.S. economy. The Republican administrations of Presidents Warren G. Harding (1865–1923 served 1921–23), Calvin Coolidge (1872–1933 served 1923–29), and Herbert Hoover (1874–1964 served 1929–33) followed a laissez-faire approach. Laissez-faire refers to the deliberate absence of government regulation. None of these presidents attempted to regulate the buying or selling of stocks and bonds they exercised no controls over banking, manufacturing, or agricultural production. Likewise, no attempt was made to gather or analyze statistics that would have pointed to increasing problems in stock investing and overproduction of agricultural products and consumer goods. This approach to government was a major contributing factor in the Great Depression.

Another general factor that contributed to the Depression was the "get rich quick" mentality that developed during the 1920s. Many Americans believed their fortune was just around the corner. This belief was fueled by the mass production of consumer goods, mass advertising in magazines and newspapers, and exotic silent movies telling tales of riches and success. With this "get rich quick" attitude, many Americans began to recklessly spend what little money they had. Hoping to look like glamorous movie stars, they bought a vast array of beauty products. On a larger scale many Americans purchased, sight unseen, parcels of land in Florida and southern California. When some investors went to visit the lots that had been purchased, they found swamps or desert. Realizing they had made a poor investment, many turned to the roaring stock market to overcome their losses. Focused on their own individual situations, these people did not recognize that their actions would soon combine with a number of other factors to produce the Great Depression.

Historians at the beginning of the twenty-first century recognize a number of causes for the Great Depression, including the following:

  • Chronic agricultural overproduction and low prices for farm products
  • Overproduction of consumer goods by manufacturing industries
  • Concentration of wealth in the hands of a few (often referred to as maldistribution or unequal distribution of wealth mal- means bad)
  • The structure of American business and industry itself, which included several large holding companies
  • Investors' speculation (buying stocks with the assumption that they can always be sold at a profit)
  • The lack of action by the Federal Reserve System
  • An unsound banking system

Causes and consequences of the Great Depression

4 Main Causes What were the 4 main causes of the great depression

A sum of different factors resulted in the collapse of the economic circuit with the consequence of a stagnation of the economy in the following years, some of them were:

  • During the 1920s the United States had great economic development . Industries were modernized and began to produce more products in less time and at a lower cost.
  • At the end of the 1920s, agricultural production and construction began to stagnate, this caused a decrease in consumption . Meanwhile, industrial companies, favored by a credit system, began to produce more than the market could consume.
  • The decline in sales of industrial products produced a wave of layoffs in industries. Unemployment, which reached 30% in the United States, resulted in an even greater decline in consumption. What were the 4 main causes of the great depression
  • Faced with rumors of the losses of companies, whose shares had reached very high values ​​in previous years, investors tried to dump the shares and therefore their price fell precipitously.

Other Causes What were the 4 main causes of the great depression

  • People began to withdraw their savings from banks, which, unable to return the entire mass of deposits at the same time, went bankrupt. The failure of the small local banks dragged down the largest banks and international subsidiaries.
  • The Great Depression cycle lasted 4 years , between 1929 and 1933, but its effects continued until the late 1930s. What were the 4 main causes of the great depression?

Consequences

The consequences of the Great Depression were felt around the world. Some of them were the following: