CAUSES OF THE GREAT DEPRESSION
Directions: Please read the “Causes of the Great Depression” article below. Then, on a separate sheet, provide at least a sentence summarizing / explaining each cause. Next, provide at least a sentence summarizing / explaining the entire article. Due Tuesday, 11/10/15!
Disagreement over the causes of the Great Depression began before the economic collapse that commenced in 1929 had even been given that name, and the disagreement has persisted ever since. Nor does the debate show any signs of imminent resolution in the early twenty-first century. Arguments over what caused the Great Depression are deeply entwined with economic, social, and political philosophy.
A major reason for the controversy is that the Depression seemingly disproved the efficacy of the unregulated free market. Defenders of the faith of classical free market economics are, therefore, obliged to seek elsewhere for the causes of the collapse of the economy following a decade of lowering taxes and lifting restrictions on business by successive Republican administrations. It is an article of dogma to them that an unfettered marketplace is self-correcting. Accordingly, devotees of Adam Smith's worldview must find fetters—some sort of government interference or regulation—on which to lay the blame.
1. WORLD WAR I AND THE ORIGINS OF THE GREAT DEPRESSION
Although it was in many ways eclipsed by the second installment of the twentieth century's world conflict, World War I (or "the Great War" as it was still known at the time of the Depression) was a major source of much of what happened in the world for most of the remainder of the century, including World War II and the Cold War. The role played by the Great War in helping to produce the Great Depression was also significant. Although the death toll from World War I was relatively small for the United States, the war was catastrophic for many European nations.
The war's economic impact was similarly profound. The war stimulated and distorted the economies not only of the belligerent nations, but those of many nonbelligerents as well. Wartime inflation was followed by postwar deflation in most countries. During the war and for several months after the armistice, demand for American farm products, especially grains, soared, as did prices. Such profitable conditions led American farmers to go deeply into debt to buy additional land and machinery. These happy circumstances for American farmers were, however, an artificial consequence of the war, which severely disrupted European agriculture. When the latter recovered rapidly after the war, the demand for the expanded production of American farms plummeted, helping (along with a sharp contraction in the money supply) to carry the economy into a sharp recession in 1920 and 1921. Agriculture was to remain in depressed conditions throughout the period of more general prosperity from 1923 to 1929.
The war also radically altered international finance. It transformed the United States for the first time from a net debtor nation into the world's largest creditor. Massive war debts owed by the British and French to American creditors were part of the economic landscape of the 1920s, as were the huge reparation payments the European victors demanded from Germany. The problem of war debts and reparations was a continuing irritant to the international economy in the twenties.
Perhaps more significant in its adverse effects on the world economy was the war's establishment of the United States in the role previously held by Great Britain as the world's banker or creditor-in-chief. This position carried with it responsibilities for which the Americans were ill prepared and that they were disinclined to shoulder. In particular, American political leaders of the twenties were committed to maintaining a favorable balance of trade, meaning that they wanted the nation to export more than it imported. This posture was, in the long term, incompatible with America's assumption of the position of the world's leading lender, because other countries had to sell more to the United States than they bought from it if they were to have the funds to repay the debts they owed to American creditors.
2. THE STOCK MARKET CRASH
This much can be stated categorically: Popular perceptions to the contrary notwithstanding, the stock market crash of October 1929 did not cause the Great Depression. Although hardly anyone realized it at the time, the economic contraction that became the Depression had already begun in the summer of 1929, when the economy started to slow considerably.
"You know," Herbert Hoover once remarked to journalist Mark Sullivan, "the only trouble with capitalism is the capitalists; they're too damn greedy." This is a truism that has been proven repeatedly, but it is also true that greed is a highly contagious disease against which few people's immune systems provide much protection. This is particularly the case when those already infected are actively working to spread the contagion, as many of them were in the 1920s. (Du Pont executive and Democratic National Chairman John J. Raskob, for example, wrote a 1929 article entitled, "Everybody Ought to be Rich.") The result was an epidemic of greed in the United States in the mid and late 1920s.
The first major outbreak of the disease in the decade occurred in Florida, where it took the form of real estate speculation. It began with the reality of the growing value of beachfront property in a place with warm winters that had been made accessible to well-to-do northeastern and midwestern residents by the development of the automobile and the construction of highways. Quickly, however, Florida real estate became a classic bubble in which prices rose far beyond realistic values, simply because they were rising. That is, speculators were willing to pay ever higher prices for land because they expected someone else to be willing to pay even more for it a week or a month later. The Florida bubble burst, as all bubbles that keep expanding ultimately must, following a severe hurricane in 1926, but the greed virus had already infected a different area: Wall Street (which was, in any case, its natural habitat).
The Great Bull Market of the late twenties was fueled by easy credit in the form of margin buying (buying stock by putting up a small percentage of its cost in cash and borrowing the rest "on margin," using the stock itself as collateral for the loan). In a rapidly rising market, the "leverage" provided by margin buying made the possibilities for huge profits extraordinary. By the time the Federal Reserve sought to dampen the speculative fever in 1928 and 1929 by raising interest rates, the mania had taken on a life of its own. "Nothing matters as long as stocks keep going up," the New York World said as 1929 began. "The market is now its own law. The force behind its advance are now irresistible."
Historian Maury Klein sums up the situation well in his book Rainbow's End (2001): "Put simply, too many people held too much stock on borrowed money." When the economy began to slow in the summer of 1929, it sent signals to Wall Street that were disregarded by most investors, but heeded by many of the richest insiders. Among those who quietly got largely out of the market before the bottom fell out were Raskob (who apparently thought that he ought to remain rich while "everybody" lost their shirts), Bernard Baruch, Joseph P. Kennedy, and President Hoover himself.
The crash was a response to an already begun, but as yet invisible to most observers, Depression. It amounted to a spectacular funeral for the "New Era" of eternal prosperity that had been proclaimed a few years earlier. Funerals, it is worth remembering, do not cause death; they recognize the decedent's passing, which has already occurred. Such was the relationship between the crash and the demise of prosperity.
The crash did, however, accelerate the downward spiral of the economy by wiping out much of the paper wealth of investors and by altering the previously euphoric outlook of so many people into one of pessimism, which led them to be much more cautious in their spending and investment. Both of these consequences of the crash further eroded demand.
3. MONETARY POLICY AND THE GOLD STANDARD
There is no question that the money supply can have profound effects on the economy. In the simplest terms, if the money supply is insufficient, prices must fall, which can lead to the sort of serious deflation that contributed to the Panic of 1893, the worst economic depression in American history prior to the Great Depression. If, on the other hand, the money supply grows faster than the demand for money, prices will rise, causing inflation. In the late 1920s and early 1930s, the most notable and recent example of the potentially catastrophic consequences of runaway price increases was the hyperinflation that had gripped Germany in 1922 and 1923, when the exchange rate between the German and American currencies went in less than two years from 192 marks to the dollar to 4.2 trillion marks to the dollar. Annualized for the two years, this was an inflation rate in excess of a trillion percent a year. By November 1923, German money was essentially worthless.
Germany's horrible experience with hyperinflation contributed to the coming of the Depression in two important ways. First, it wreaked havoc on the German economy and those of several other central European countries, and they never fully recovered from the effects for the remainder of the decade. Second, the German disaster caused other nations to be unduly concerned with avoiding inflation when the more dangerous economic predator lurking in the shadows of late twenties prosperity was actually deflation. In their efforts to defend their nations against inflation, political and economic leaders inadvertently strengthened the building forces of deflation.
In the decades prior to World War I, most major countries had been on the gold standard, meaning that their currencies were convertible to a set amount of gold. This meant that the value of all currencies on the gold standard had a stable exchange rate with other currencies that were tied to gold. The gold standard was abandoned by most of the belligerents during World War I (the United States, a late entrant into the war, remained on the gold standard), but there was a concerted effort to restore it after the war. Because of the major disruptions of the war, exchange rates were allowed to float from 1919 to well into the 1920s. Such floating rates provided some protection against the problems in one or a few countries spreading to other countries, but most nations' governments were committed to returning to the gold standard with fixed rates of exchange as rapidly as possible. Great Britain did so in 1925 and France followed in 1928. By 1929, forty-five nations were on the gold standard.
By 1929, much of the world's gold was rapidly flowing into the United States and France. Attempts by various countries to keep their currencies at prewar exchange rates led them into deflationary policies, intended to cheapen the prices of their products on the international market and so bring gold back into their countries to support their currencies. These deflationary actions contributed to a worldwide contraction in economic activity.
4. TECHNOLOGY AND THE DEPRESSION
Technology was in three major respects a significant factor in creating the conditions that produced the Great Depression.
First, new technologies provided much of the impetus for the unprecedented prosperity of the 1920s. The development of important new products that large numbers of people can be persuaded to buy is often the driving force in periods of economic boom, as appears to have been the case with personal computers and the Internet in the boom of the 1990s. The development of such new consumer products encourages investment in new plants and equipment and provides employment for large numbers of workers. This was plainly the case with the automobile in the 1920s. The motor car was not new in the twenties; nor was its method of mass production, which had been perfected prior to World War I. What was new in the decade following that war was the enormous expansion of the market for cars and the rapid development of numerous industries that were stimulated by the mass ownership of automobiles. Among these booming industries of the prosperity decade that preceded the Depression were petroleum (exploration, drilling, refining, and retailing); steel production; road and highway construction (which pulled along the cement industry); and motels, diners, and tourist attractions.
Nor was the automobile alone among new technologies that had been developed by the early 1920s in providing fuel for the economy of the decade. Radio, little more than a promising curiosity at the decade's start, had spread across the nation and into the homes of a majority of Americans by 1929. Along with the automobile and, to a lesser extent, a variety of new household appliances, the swift rise of radio to the status of "necessity" for middle-class life provided an enormous stimulus to the economy.
It should be noted that while the potential market for radios and electrical appliances was huge, it was limited to areas where electricity was available. Although all densely populated parts of the United States were electrified, large expanses of rural America were not, so rural Americans were not part of the potential market for electrical devices. Additionally, while there was no such access barrier to farmers buying automobiles (and many did buy them), the fact that agriculture remained economically depressed throughout the decade also reduced the potential market for automobiles among the nation's farmers.