Causes of the Great Depression

Introduction

The boom years of the 1920s seemed to come to an abrupt end with the Wall Street Crash of October 1929. However, this was not the only cause of the global financial crisis that consumed America in the 1930s. In fact, there were many causes of the Great Depression, including bank failures, overproduction, and structural failings in the banking system.

Overproduction

Mass production was a cause of both boom and bust. Whilst it had fuelled the mass consumption in the 1920s, by the end of the decade, demand could not keep up with production. Many people had financed purchases of consumer products with loans and credit, so after the Wall Street Crash it became almost impossible to pay off these debts. As the economic crisis engulfed the developed world, America was unable to sell these goods to Europe either.

Overproduction was also the cause of an agricultural economic crisis. By the middle of the 1920s American farmers were producing more food than the population was consuming. To keep up with demand during World War One, farmers mechanised their techniques to increase output. However, this was an expensive process that put many farmers in debt.

Furthermore, land prices for many farmers dropped by as much as 40 per cent. As a result, the agricultural system began to fail throughout the 1920s, leaving large sections of the population with little money and no work. Thus, as demand dropped with increasing supply, the price of products fell, in turn leaving the over-expanded farmers short-changed. This saw unemployment rise and food production fall by the end of the 1920s.

Uneven incomes

Not all Americans benefited from the nation’s boom years. Wealth was distributed unevenly in the 1920s and 60 per cent of the population still lived below the poverty line. The top one per cent of workers in 1929 saw their income rise by 75 per cent; the bottom 99 per cent meanwhile only enjoyed a nine per cent rise in wages. This meant that the majority of the population could not keep apace with the steady increase in industrial production. This uneven distribution of wealth limited economic growth and made the boom years unsustainable.

Wall Street Crash

The Wall Street crash began on Black Thursday, 24 October 1929. This marked the beginning of a rapid decline in the value of shares. By 28 October - Black Tuesday - the value of stocks traded had reached a record high. This is often considered the first day of the Great Depression.

The stock market boom was largely built around speculation. Furthermore, many people bought stocks on credit – the investor only required to have five per cent of the value of the stocks they bought, with the rest being supplied by a loan – this buying on credit is otherwise known as ‘buying on margin’.

A market built on speculation coupled with the short-term outlook of the investors was not a manageable way to run a stock market and did not afford the consistency and stability required for the system to yield benefits for the wider economy. In March 1929, when many of the middle classes who had a lot invested in the market, suddenly became nervous and sold their stock, there was a mini-crash. This highlighted the weak foundations of Wall Street.

While the market recovered to record highs in early September 1929, it was not to last – on 20 September the London Stock Exchange crashed again and this truly tested the nerve of investors. A month later, on 24 October, mass panic saw the market lose 11 per cent of its value before trading had even begun. This resulted in a perpetuating state of panic and in the following five days until Black Tuesday people sold their stock en masse – on Black Monday and Black Tuesday alone the market lost $30 billion, triggering a collapse of the stock market and with it much of America’s economic structure.

Weak banking system

Another cause of the Great Depression was the structure of America’s banking system. The country had thousands small banks that were unable to cope when people withdrew their money en masse. In 1930 a wave of banking closures swept through the mid-eastern states of the US for this reason. Lending and credit dried up as a result of banks selling assets, borrowing off other banks or shutting down. Without access to credit, people bought less goods.

The knock-on effect to this was the closure of factories. Increased unemployment lowered consumption even further. By 1932 many businesses were out of work, banks were closed and 20 per cent of the American workforce were unemployed.

European recession

As America witnessed a turbulent decade of boom and bust in the 1920s and early 1930s, Europe too suffered from its own economic problems.

World War One had depleted the European workforce and led to huge debt, mainly owed to the US. When America’s economy faltered it called on Britain and France (among other countries) to repay their debts ,while also making Germany pay the war reparations.

The fragile economies of Western Europe were not able to survive without the money they had relied on from the US. As lending from across the Atlantic stopped and President Herbert Hoover requested the debts to be repaid, these European economies suffered a similar fate as their wartime allies. None of these countries were able to buy America’s consumer goods, a problem exacerbated by the fact that America raised tariffs on imports to an all-time high, which all but ended world trade at a time when trade and economic stimulus was needed the most.

European economies collapsed when they were already struggling to rebuild themselves; unemployment levels rose, products became overproduced with fewer people able to buy them, the value fell, and deflation ensued as the economic structure collapsed in on itself. This pattern, first seen in America, spread to much of the developed world.

Hoover’s failures

President Hoover is often blamed for the economic policy that led to the Great Depression. People argue that Hoover did not do enough at a time when economic action was desperately needed.

Hoover did try to launch initiatives and invest money back into schemes to encourage lending. However, these are often seen as too little, too late. His decision to increase tariffs on imports through the Smoot-Hawley tariff stifled trade with other countries and shrank the size of the market American manufacturers could sell to. Furthermore, under Hoover the federal government raised its discount rate, making credit even harder to come by. Other actions he took also came too late – plans made in 1932 could not do enough to bail out banks and put people back in work as the depression had fully taken effect.

Hoover’s lack of a proactive approach was highlighted when Roosevelt took immediate action to provide relief and recovery. Initiatives like the New Deal put large numbers back in work and stopped the downward spiral of unemployment and deflation.

The gold standard

The decision to return to and then stick with the gold standard after World War One by Western nations is often cited as one cause of the Great Depression. The gold standard is a system in which money is fixed against an actual amount of gold. In order for it to work, countries need to maintain high interest rates to attract international investors who bought foreign assets with gold. When this stops, as it did at the start of the 1930s, governments must often abandon the gold standard to prevent deflation from worsening. However, countries delayed in making this decision. The delay in abandoning the gold standard worsened economic problems and increased the size and scale of the Depression.

Conclusion

The causes of the Great Depression are debated by historians and economists. Many make the mistake of viewing the Depression as a direct result of the Wall Street Crash. In reality, it was a global depression that had roots in a flawed banking system and the unsustainable prosperity of the 1920s. The factors combined in a spiral of despair that resulted in the Great Depression of the 1930s.