Causes of the great depression

Causes of the great depression- Assignment Help

The Great Depression was the worst economic period in US history.

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It lasted roughly a decade: from 1929, the year the stock market crashed, to 1939, when the US started mobilizing for World War II. Industrial production fell by nearly 47% and gross domestic production (GDP) declined by 30%. Almost half of US banks collapsed, stock shares traded at a third of their previous value, and nearly one-quarter of the population was jobless — at a time when unemployment insurance didn’t exist.

While the stock market crash of 1929 marked the start of the crisis, it wasn’t — contrary to popular belief — the sole reason for it. Many other factors combined to create the Great Depression, from ill-timed tariffs to misguided moves by the young

Federal Reserve

. “The crash was not a cause, but a triggering event,” says Barry M. Mitnick, a professor of business administration and of public and international affairs at the University of Pittsburgh’s Katz Graduate School of Business.

But periods of economic contraction, and economic growth, are natural to the

business cycle

. The average US recession since World War II lasted 11 months. The

recession

in the mid-2000s, dubbed the Great Recession, lasted 18 months. However, the Great Depression ravaged the economy for roughly a decade, from 1929, the year the stock market crashed, to 1939, when the US mobilized its economy for World War II. While the stock market crash of 1929 officially marks the start of the crisis, “the crash was not a cause, but a triggering event,” says Barry M. Mitnick, a professor of business administration at the University of Pittsburgh’s Katz Graduate School of Business. The Great Depression’s causes aren’t entirely dissimilar to those of a typical recession, though compounded on a grander scale and exacerbated by ill-timed tariffs and misguided moves by a young Federal Reserve.

Yet, if the causes of the Great Depression can be seen in other recessions, is it possible for the economy to fall into another depression?

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. It marked a period of exorbitant economic growth. Between 1922 to 1929, the gross national product grew at an average annual rate of 4.7%, while the unemployment rate dropped from 6.7% to 3.2%. Total wealth in the US more than doubled, though most of that growth was experienced by the wealthiest Americans. Individual Americans also started investing in the market in a big way.

But all was not as roaring as it seemed. Consumers spent outside of what they could afford, and companies over-produced to keep up with this demand. Financial institutions became heavily involved in stock market speculation. In some cases, they created subsidiaries that offered their own securities. Brokers secretly sold 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 making choices based on research or 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.

2. Stock market crash of 1929

Catching on to the market’s overheated situation, seasoned investors began “taking profits” in the autumn of 1929. Share prices started to falter.

Prices first crashed on Thursday, Oct. 24, 1929, when the markets opened 11% lower than the previous day. After this “Black Thursday,” the market rallied briefly. But prices fell again the following Monday. Many investors couldn’t make their margin calls. Wholesale panic set in, leading to more selling.

3. Oversupply and overproduction problems

Mass production powered the 1920s consumption boom. But it also led to overproduction on the part of many businesses. Even before the crash, they started having to sell goods at a loss.

A similar crisis was occurring in agriculture. During World War I, farmers had bought more machinery to boost production — a costly move that put them in debt. But, in the post-war economy, they ended up producing far more supply than consumers needed. Land and crop values plummeted.

It all resulted in a drop in prices, both agricultural and industrial, which decimated profits and hurt already over-extended enterprises.

4. Low demand, high unemployment

During periods of economic recession, consumers stop spending, which forces companies to cut production. With less output, companies start laying people off, raising the unemployment rate. A healthy unemployment rate in the US hovers between 3% to 5%. During the peak of the Great Depression, the unemployment rate peaked at 24.9% in 1933 — 12.8 million Americans out of a population of 125.6 million — and it was still as high as 17.2% in 1939.

5. Missteps by the Federal Reserve

During the Great Depression and years after, the brunt of the responsibility for the crisis was placed on the private sectors, banks irresponsibly letting their reserves get too low. This was until 1963, when economists Milton Friedman and Anna Schwartz published a study that revealed monetary policy from the Fed was largely to blame.

In 2002, Ben Bernanke, a member of the Board of Governors of the Federal Reserve, said as much. “I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again,” Bernanke said in an address during Friedman’s 90th birthday.

By keeping interest rates low in the early to mid-1920s, the Fed contributed to the heady expansion. Then, after the crash, it did just the opposite of what economists would advise today: Instead of lowering interest rates, the Fed raised them, doubling them in 1931 from their pre-Crash levels. The idea was to discourage lending and borrowing — the “wild speculating” that encouraged the market to bubble, then burst.

The Fed also followed the “liquidationist” policy of then-Treasury Secretary Andrew Mellon, a policy in which the central bank stands aside and lets troubled banks collapse. Theoretically, a stronger, sounder banking system would emerge. The policy ended up taking out smaller banks, not necessarily bad banks. By 1933, 11,000 of them had failed, wiping out the savings of millions.

Ultimately, the decrease in the money supply led to deflation. That, in turn, caused sky-high increases in real interest rates, which choked off any chances of companies investing or expanding.

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