Causes of Great Depression Essay

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Causes of Great Depression

The economists and historians have not been able to reach an agreement regarding the causes of the depression. Most of them argue that the extensive stock market speculation was the major cause of depression. However they differ in the magnitude of effect of stock-market crash on the great depression. Milton Friedman says in this regard; “I don’t doubt for a moment that the collapse of the stock market in 1929 played a role in the initial recession” (Parker, 49)

Another economic historian Temin (1976) only attribute a minor role to the speculation and stock market crash as the cause of great depression. Other economists speculate that stock market crash set an impetus for great depression and was the primary cause of this economic devastation. For example, the research studies by Romer (1990) and Flacco and Parker (1992) provides verified and verifiable evidence that speculation and stock market collapse were the primary source of consumers uncertainty in the economic activity that finally led to great depression.

As usual the period of depression was preceded by a long period of speculation. The prosperity of the 1920s has benefited only a small group of people who owned great businesses. These people made huge profits in the form of dividends. No doubt in these big businesses hundred and thousands of stockholders had also shares but their investments were purely of marginal nature. The major share in these concerns was in the hands of comparatively small number of people. It is estimated that in 1929 almost 78% of the dividends from the great industries, railroads, oil companies and other combines went to 0.3% population, headed by a handful of multi-millionaires. Gusmorino (1996) says in this regard;

According to a study done by the Brookings Institute, in 1929 the top 0.1% of Americans had a combined income equal to the bottom 42%2. That same top 0.1% of Americans in 1929 controlled 34% of all savings, while 80% of Americans had no savings at all3. Automotive industry mogul Henry Ford provides a striking example of the unequal distribution of wealth between the rich and the middle-class. Henry Ford reported a personal income of $14 million4 in the same year that the average personal income was $750.

As a result of speculation wave which swept the country during the years 1928-1929, the stock market reached new heights. This boom was caused by a large number of people speculating in shares of stock ‘on margin’. Under this system speculator deposited only as much money with their brokers as was sufficient to cover the probable range of fluctuations. Speculation in shares is resorted to because the price of the shares is rising and seems likely to rise. Tempted by the possibility of an easy fortune and wealth, in the late 1920s, people from different walks of life and professions freely indulged in stock speculation. For some time the prices of the shares showed a steady rise and reached an all time record in 1928-1929. Hall and Ferguson states that:

The Federal Reserve began expressing concern in early 1928 and at that time began a policy of monetary restriction in an effort to stem the stock market advance. This policy continued through May 1929. The monetary restriction was carried out by selling $405 million in government securities and raising the discount rate in three stages from 3.5 percent to 5 percent at all Federal Reserve banks.

But it was a late move as in October 1929, the stock market collapsed following Britain decision to raise the rate of interest to six and a half percent, with a view to attract back the capital that had been invested in United States. As a result many European holdings were thrown on the market and the prices of the shares began to sag. Once the process fell, the speculator started selling their stock-shares to avoid bigger losses.

Once selling on larger scale started, this affected the confidence of the others who also fell in line. As a result of this stock market collapse, an unparalleled depression overtook United States. The prices started falling sharply, foreign trade declined, factories curtailed production, real-estate declined, new construction practically ceased, wages were cut and unemployment began to increase.

Over-production of agricultural products is considered as another cause of great depression. As the farmers produced more wheat, cotton, corn and other cash crops than could be consumed, as a result there was sharp decline in the prices and purchase of farm products. This affected the purchasing power of the farmers, Furthermore, the farmers had assumed heavy mortgage during the prosperous times, which further curtailed their purchasing capacity. This inevitably cut down the market for the manufactured goods and prevented the factories from producing to their full capacity and stood in the ways of the workers getting employment. So it was cause and effect phenomenon.

Over-production in the industrial sector also augmented the depression. In the years of boom which followed by World War I, the American manufacturers, encouraged and captivated by huge profits had made too many goods which could not be consumed by the home market. Ultimately these manufacturers were compelled to cut down the production which meant dismissing a number of workers.

The unemployed workers had very little or no capacity to spend which meant further reduction in the production of goods. As the depression grew, this process continued. For sometime the production of these merchants was consumed by the domestic consumers due to system of installment buying. However, carried to extreme, this plan of installment buying was dangerous and completely dried up the future purchasing power and increased the load of private debts.

The introduction of the labor-saving devices also led to greater production with less labor. As a result of introduction of the machines, a large number of men were thrown out of jobs and usually they failed to secure alternative jobs. This meant diminishing capacity of the labor to purchase.

The Gold standard and money hoarding also contributed toward the increase of depression. Due to economic unrest caused initially by bathed stock market crash compelled the people to hoard large amounts of money. As America had a 100% gold standard at that time, so circulation of money became a major dilemma for the Federal Reserve Board. Money supply dropped radically. However Professor Richard Timberlake (2005) negates this preposition and holds that the gold standard could not held accountable for the Great Depression, because Federal Reserve Board was not pursuing a austere gold standard even earlier.

As a result of the war, the economies of the European powers were badly shattered and they owed huge debts to United States. Most of these debtor nations made an effort to buy as little as possible and sell more to United States. For sometime the American investor kept the international trade machinery working by providing huge loans to the foreign powers. But once the borrowers reached a point where their capacity to repay ceased, the loans were stopped. This greatly affected the American trade. Gusmorino (1996) holds the view;

A last major instability of the American economy had to do with large-scale international wealth distribution problems. While America was prospering in the 1920’s, European nations were struggling to rebuild themselves after the damage of war. During World War I the U.S. government lent its European allies $7 billion, and then another $3.3 billion by 1920. By the Dawes Plan of 1924 the U.S. started lending to Axis Germany. American foreign lending continued in the 1920’s climbing to $900 million in 1924, and $1.25 billion in 1927 and 1928.

Further, the American government adopted huge tariffs (Fordney-McCumber Tariff 1922 and Hawley Smooth Tariff of 1930) which checked the inflow of European goods into United States. The European powers retaliated by erecting tariff barriers against American goods. As a result the American exports to overseas markets fell considerably.

Randall Parker add another psychological dimension to these material and monetary causes of great depression. He analyzes that pessimistic expectation of the investors and the consumers also contributed greatly toward solidifying depression. He further says;

…the behavior of expectations should also be added. As explained by James Tobin, there was another reason for a “change in the character of the contraction” in 1931. Although Friedman and Schwartz attribute this “change” to the bank panics that occurred, Tobin points out that change also took place because of the emergence of pessimistic expectations. If it was thought that the early stages of the Depression were symptomatic of a recession that was not different in kind from similar episodes in our economic history, and that recovery was a real possibility, the public need not have had pessimistic expectations.

Instead the public may have anticipated things would get better. However, after the British left the gold standard, expectations changed in a very pessimistic way. The public may very well have believed that the business cycle downturn was not going to be reversed, but rather was going to get worse than it was. When households and business investors begin to make plans based on the economy getting worse instead of making plans based on anticipations of recovery, the depressing economic effects on consumption and investment of this switch in expectations are common knowledge in the modern macroeconomic literature.

In addition to these above factors, certain other factors also operated either o cause the depression or to make it worse once it had come. These included (i) the increase in population rate was much less than the production rate, which reduced the consumers.; (ii) the disappearance of the western frontier, which meant that America could no lo9nger move in that direction during bad times and (iii) political unrest in Europe, Asia and South America, due to inter-governmental debts, also aggravated the great depression in United States.

References

Gusmorino, Paul A., III. `Main Causes of the Great Depression.` Gusmorino World (May 13, 1996). http://www.gusmorino.com/pag3/great_depression/index.html

Flacco, Paul R. and Randall E. Parker. “Income Uncertainty and the Onset of the Great Depression.” Economic Inquiry 30, no. 1 (1992): 154-71.

Hall, Thomas & Ferguson, David. The Great Depression: an international disaster of perverse economic policies. Ann Arbor : University of Michigan Press, 1998.

Kaiser, David E. Economic diplomacy and the origins of the Second World War: Germany, Britain, France and Eastern Europe, 1930-1939 (1980)

Parker, Randall E. Reflections on the Great Depression. Northampton, MA, USA : Edward Elgar. 2002.

Parker, Randall E. An Overview of the Great Depression. Economic History Association.
http://eh.net/encyclopedia/article/parker.depression

Temin, Peter. Did Monetary Forces Cause the Great Depression? New York: W.W. Norton, 1976.

Timberlake, Richard. Gold Standards And the Real Bills Doctrine in U.S. Monetary Policy. Economic Journal Watch. VOL.2. No. 2. (August 2005). 196-233.

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