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Historians pretty much agree that the Great Depression of the 1930's was the worst business cycle our country has been subjected too in modern times. What really caused it though?
I've heard alternative hypotheses expressed over the years:
1. An economy that was producing alot, but not consuming so much.
2. Monetary contraction that occurred as the government early on made the decision to allow a number of banks that they perceived as badly run to fail. There is also a question as to whether the federal reserve allowed real interest rates to rise.
3. Loss confidence in the economy by business and consumers that resulted in an unwillingness to spend and invest.
Also, why did it last so long? Government spending and tax cuts are frequently used these days to shorten business cycles. When FDR took over the presidency, he engaged in deficit spending to try to re-start the economy. Yet, most historians don't believe the USA started to climb out of the Depression until about 1940 when our factories were producing armanents for the Second World War. Are there any lessons we can take out of the Great Depression for use today?
Great question! The short answer would be WWI debt, overproduction of agriculture and consumer goods, unregulated stock market (sound familiar?), and high tariffs. The Smoot-Hawley Tariff of 1930 is said to have exacerbated the Depression. As some are often wont to say, Roosevelt didn't solve the Depression, but many feel that his actions saved capitalism. Actually, Roosevelt did initiate some of the ideas originally put forth by the Hoover administration.
I'm not sure of the authenticity of this story, but it's said that just before the stock market crash Bernard Baruch stopped one morning to get his shoes shined. The young man at the shoe shine stand started giving Baruch tips on what stocks to buy. This alarmed Baruch and he thought, when the shoe shine person starts giving investment tips, it's time to get out of the market. It's said he drew all of his money out before the crash.
Last edited by John Walmsley; 12-29-2009 at 05:21 PM..
Reason: corrected punctuation and added words
The Great Depression lasted a long time because the big banks wanted to consolidate wealth in the hands of a few. It worked pretty well too.
The 1920s were "roaring" because of easy credit giving the ability to start up businesses, and people were realizing huge gains on the stock markets with credit. Then, almost at once, all the major banks started calling in their debt obligations, which caused everyone to sell, which caused huge losses, and thus people couldn't settle their debt obligations, which forced banks to eat the losses and eat into their reserves, which panicked people, who then withdrew their money, which exacerbated the situation and forced thousands of banks to fail practically overnight.
After that, gold was confiscated by the government and used as a reserve metal even though FDR released the dollar from the gold standard. This enabled the government to spend on debt and not require tax increases or a devaluation of the money. Prior to this, the dollar was backed by gold and $1 was equal to something like 1/32nd of an ounce of gold. Any increase in the federal spending ceiling would require either more gold to be found or the dollar devalued - it wasn't free credit like today.
The credit contraction caused millions of businesses to fail and caused many people to lose their jobs. Someting like 33% unemployment rate. Credit was so tight that people would borrow from prospective neighbors when buying a new house. Since jobs were so hard to come by, nobody was willing to spend much money, and since people weren't spending money, businesses couldn't expand.
It was really WWII that got us out of the Depression. The USA was neutral before the Japanese bombed Pearl Harbor, even though we were making weapons for the Allies. Heck, we even lent Britain the money to pay for the bombers we gave them, and we billed them for the support we gave them after we officially entered the war! It wasn't until last year that they finally paid it all off. After the war, we experienced a mini Depression until people graduated from college under the GI Bill and started producing high tech stuff and manufactured stuff for the rest of the world to rebuild.
Few questions are more debated among economist. There is not, and won't be, any agreement on this. I list a few of the many explanations (in no particular) order.
1) Growing income imbalance in the twenties that led to a lack of purchasing power.
2) Failings of key financial institutions and (later) a lack of trust in them by the public.
3) A loss of confidence in the public and elites (including business) in the economy that led to a lack of investment or purchasing. People became extremely cautious in hiring or purchasing which fueled the continuing problems.
4) Government intervention (or lack of intervention) in the economy.
5) Increase in protectionism.
6) Disruptions in the world economy, particulalry in Europe, after the First World War. Caused by the war. Many of Europe's best minds and workers were killed in the war, those who had the most initiative were more likely to die. And long standing economic factors such as banking and trade were harmed by the new political divisions, increased debt, and efforts to punish Germany.
7)Low commodity prices.
8) Technical explanations such as monetary policy or licquidity issues.
Interestingly, after 1933 GDP grew fairly rapidly in the US (although it weakened temporarily in 1937). It was jobs and wages that failed to grow.
Yet, most historians don't believe the USA started to climb out of the Depression until about 1940 when our factories were producing armanents for the Second World War. Are there any lessons we can take out of the Great Depression for use today?
That's the problem with historians, ignoring economic data. Clearly all economic indicators were in recovery by 1934. If the argument is that full recovery wasn't achieved until 1941 then the historians would be correct.
A passing note, Roosevelt, contrary to conventional wisdom, was not a full pledge adherent of John Maynard Keynes, in fact Roosevelt had serious doubts about his economic prescriptions which led him to fall off the tracks in 1937 when he decided to balance the Federal budget. Keynes was right and Roosevelt, like Obama (there I said it), was wrong.
Ask 100 economists, and you'll get 100 answers. That's because there were a lot of factors that contributed.
Somebody wisely mentioned the Hawley Smoot Tariff Act of 1930, which was the equivalent of fighting a middling brush fire with a gallon or so of gasoline. However, another act that deserves mention were the agricultural import acts of the early 20s that were designed to protect American farmers, and actually did the opposite and cost foreign markets for American agricultural products. In 1922, a bushel of American wheat sold for roughly $1.00. By the time 1929 rolled around, that same bushel could only fetch 25 cents. This, in turn, caused the whole sale evisceration of the rural economy in America.
The other factor was the wholesale expansion of credit during the 1920s (Kind of like the same phenomenon of the 1990s and 2000s). Because the Federal Reserve was artificially expanding the money supply, it was leading to speculation in stocks, real estate, and a host of other areas far beyond any sane economic measure.
The result? The total meltdown of the American Economy. People tend to use the Stock Market Crash as the milestone that started the Great Depression. In actuality, it was the Great Depression that caused the Stock Market Crash. A lot of the machinery had already been set in motion, even though it would not be evidenced in the unemployment lines until 1930 and onward.
So two major causes of the Great Depression, trade barriers and the artificial expansion of credit, can be laid at the feet of the Federal Government. The aggravating factors such as the Hawley Smoot Tariff Act, the massive increase in personal taxes, and the intense regulatory environment imposed on business probably did a great deal to retard the recovery. It says a lot that the unemployment rate in 1937 was almost as high as the unemployment rate in 1932, and would remain high until 1940, when war production began to kick in. Which means that the antics Adolph Hitler, not the policies of FDR, probably saved the country from permanent depression.
Personally I believe it was primarily caused by a lack of purchasing power tied to the very low wages paid to most and later both tarrifs and a psychological effect that made people unwilling to invest or purchase. In that respect FDR was right in noting that what we had to fear was fear itself, unreasoning fear.
This reflects my liberalism of course, I am a Keynsian as are nearly all of them. If economic intervention by the federal government caused the depression, than Hitler would not have brought Germany out of depression by the massive intervention he launched in 1934, nor would have the US during the war. Hitler was popular in large part because he ended the depression in Germany by putting people to work.
That said FDR was most certainly not a Keynsian, he built the New Deal on no one theory but on a series of essentially ad hoc experiments, many contradictory. He was infamous among New Dealers for his inconsistancy, rejecting the views of those who prefer classical market of interventionary strategies. In 1937 when he felt the country had recovered he sharply cut back on federal spending, sending the country right back into serious trouble.
There is a good deal of misunderstanding of what physically occured in the US during the Great Depression. Its often said that the country had not recovered as late as 1941. That is only true if you are looking at employment. In terms of GDP, commonly used to measure a recession, the country had made signficant progress by that time.
Personally I believe it was primarily caused by a lack of purchasing power tied to the very low wages paid to most and later both tarrifs and a psychological effect that made people unwilling to invest or purchase. In that respect FDR was right in noting that what we had to fear was fear itself, unreasoning fear.
This reflects my liberalism of course, I am a Keynsian as are nearly all of them. If economic intervention by the federal government caused the depression, than Hitler would not have brought Germany out of depression by the massive intervention he launched in 1934, nor would have the US during the war. Hitler was popular in large part because he ended the depression in Germany by putting people to work.
That said FDR was most certainly not a Keynsian, he built the New Deal on no one theory but on a series of essentially ad hoc experiments, many contradictory. He was infamous among New Dealers for his inconsistancy, rejecting the views of those who prefer classical market of interventionary strategies. In 1937 when he felt the country had recovered he sharply cut back on federal spending, sending the country right back into serious trouble.
There is a good deal of misunderstanding of what physically occured in the US during the Great Depression. Its often said that the country had not recovered as late as 1941. That is only true if you are looking at employment. In terms of GDP, commonly used to measure a recession, the country had made signficant progress by that time.
You make good points. However, I would argue that recovery would have taken place without government intervention, and that government intervention may have actually retarded growth, particularly when you consider things such as the imposition of tariffs and the sudden and sharp elevation of taxation levels. Further, given that US unemployment in 1939 was still at 17.9%, seven years after FDR took his oath of office, I'm not sure how you can blithely argue that as 'significant progress.'
I think an excellent illustration of this point is comparing the Great Depression with the Depression of 1921, the Depression nobody talks about. There's a reason nobody talks about it--because it was so short-lived. Yet the economic decline was far worse than the Great Depression and the subsequent recovery was far quicker.
For example, during the Depression at the beginning of the 1921, prices declined 56% for the year. That's right: 56%, as in the average costs of goods and services declined by HALF. What's more the Gross National Product declined 24 PERCENT during the same period. This was a catastrophic hit to the economy, no matter how you choose to analyze it.
Now what is instructive here is how Warren G. Harding chose to respond to the economic challenge: By doing nothing. Instead of slinging untold billions into government makework projects and ratcheting up taxation levels like Hoover and Roosevelt would do in the 1930s, the President instead dismantled the large bureaucracies that sprang up during World War I. He also opposed excessive government interference in the private sector and instead worked to control government debt.
In short, Harding actually maintained a friendly environment for investors by ensuring a decent return on capital investments, something that Roosevelt never was willing to do. This is an important point, because recessions are essentially price adjustments, and the greatly lowered cost of investment after sharp downturns like those of 1921 and 1929 would have presented ideal investment opportunities. Except that investors in The Great Depression were not given a favorable investment climate.
Why? FDR's resulting top Federal tax rate of 79% guaranteed that those with money would not actually put their holdings back into circulation, which meant less investment in new production and hiring. After all, in a Depression, cash is king. Why pony up your own money if you will see upwards of 4/5ths of your return taken by Washington? This is why, while there was indeed a rebound in the GNP in the 1930s, the employment picture remained bleak.
The result of Harding's policy, or lack thereof? Unemployment declined from 12% at the height of the 1921 Depression to 3.2% in 1923, a dramatic recovery by any definition, and a robust climate for the economy immediately afterwards. So while we remember the 1930s as a time of economic despair, everybody remembers the 1920s as a time of economic expansion, despite a depression that was actually worse in its initial stages than the one that would follow eight years later.
Last edited by cpg35223; 12-30-2009 at 09:28 PM..
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If economic intervention by the federal government caused the depression, than Hitler would not have brought Germany out of depression by the massive intervention he launched in 1934, nor would have the US during the war. Hitler was popular in large part because he ended the depression in Germany by putting people to work. 
