International Impact of the Great Depression

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Any analysis of the Great Depression must start with World War I. This conflict had a dramatic economic impact, which went far beyond the massive military casualties. It embraced non-belligerents as well as those directly involved in the conflict. The war encouraged but also grossly distorted economic effort.


All wars are inflationary and World War I was no exception. Everywhere farm and factory prices rose inexorably and continued their upward course even after the conflict ended in 1918. For most countries the postwar depression of 1920 and 1921 was the sharp deflationary shock, which brought to an end war-induced price increases. In Germany, however, hyperinflation continued and currency stability was not achieved until 1924, and then only with the assistance of U.S. bankers.

War needs radically altered international indebtedness. In order to pursue the conflict with full vigor, the British and French governments borrowed extensively from U.S. private lenders and also, after America had joined the conflict in April 1917, from the federal government. Once the war was over, Washington insisted upon repayment of the debt even though the economies of both Allied nations had been seriously weakened by four years of conflict. For other stricken European countries, international indebtedness continued to rise after 1918. Desperately short of foodstuffs and raw materials, these countries had to contract postwar relief loans from the U.S. government and use the dollars they received to purchase American products.

The British and the French did not worry unduly as they ran up a large war debt bill because they assumed that a vanquished Germany would meet the costs of the war. In 1921 a reparations total was agreed upon by the non-U.S. allies and imposed upon Germany. The Germans viewed the reparations bill as outrageous and the sum far too large for them to pay. The victors were convinced that Germany could pay if its exports were competitive and the foreign currency they earned was transferred to the Allies. However, the prospect of maintaining a low-wage, high-tax economy for many decades after the hardships of war and postwar turmoil had no appeal to Germans.

The United States did not take part in the reparations negotiations and did not seek payment from Germany. Reparations were paid principally to Britain and France, which had begun payment of their war debts to the United States. One problem was that neither of the two recipients could be confident of regular payments while hyperinflation consumed Germany. Eventually the fear of mounting economic instability became so great that American intervention to stabilize the German currency was proposed. The intervention was not governmental because Washington did not want to enter any negotiations in which concessions on war debts might be demanded. American bankers produced the Dawes Plan, which in 1924 brought the frightening hyperinflation to an end and gave a New World stamp of approval to Germany. To support the Dawes Plan, the Federal Reserve (Fed) resolved to keep U.S. interest rates low, thus making Germany, where rates were high, attractive to the American investor. Soon Germany became the world's leading international borrower and American citizens very willing lenders.

The war created a new group of indebted nations and transformed the United States, the world's leading debtor nation in 1914, into the status of leading creditor nation four years later. During the 1920s the United States assumed the role of leading international lender.


High war prices encouraged the producers of foodstuffs and raw materials to expand output. Indeed, many countries were prepared to go into debt to fund roads, which would open up new areas of production, and docks that were vital to an expanded export trade. The United States was the only source of funds for virtually all borrowers. However, the depression of 1920–1921, which reduced prices savagely and suddenly, had a devastating effect on primary producers, virtually all of whom were in debt. Moreover, once European agriculture recovered from the war, surpluses in internationally traded commodities such as wheat began to appear. European countries, with the exception of the United Kingdom, protected their exposed farmers with high import duties. As stocks of coffee, cotton, and sugar mounted, exporters of these products found it difficult to pay for the imports of manufactured goods they wished to consume. Indeed, some found it difficult to fund the interest on the debt that they had run up when times were good and prices high. It was tempting, but not realistic, to view such problems as temporary and to borrow, usually from the United States, to meet bills and pay for imports. There is some evidence to suggest that American international lending, which was poorly regulated, became more unsound as the twenties progressed. Many U.S. banks, new and enthusiastic entrants to this profitable business, were as devoid of good judgement as were the eager borrowers. By 1928 many primary product producers had become dependent upon a steady stream of American funding.


Many countries had temporarily abandoned the gold standard during the war, and there was a widespread conviction that this discipline should be embraced again as soon as possible. In part this belief was connected to the pre-1914 era view that the gold standard had ensured stability. Moreover, the devastating hyperinflations in central Europe seemed to indicate that a rigid discipline was needed if the worst excesses of economic mismanagement were to be avoided. Indeed the return to gold was seen as an essential prerequisite for the restoration of normality to war devastated economies.

Contemporaries debated about how soon their economies could return to gold and at what exchange rate, but never questioned if this move was wise in a world so different from the one before August 1914. The choice of exchange rate was crucial. The wrong rate would lead to formidable problems if it proved difficult to defend during an economic crisis, as devaluation was not an option. Gold standard countries that came under pressure had to deflate in order to make their exports more competitive through cost reductions, which inevitably caused rising unemployment and wage cuts.

Nations returned to gold not in an orderly, but in a piecemeal, fashion and many had slender gold reserves. Moreover they returned at different exchange rates. For example, Britain returned in 1925 at the exchange rate that had been in force in 1914: ¶1 = $4.86. This rate would be difficult to defend given Britain's reduced economic circumstances. On the other hand, the French franc that went back on gold in 1926 was worth only one-fifth of the 1914 franc. Thus the low value franc made it far easier for the French to penetrate export markets than British business, which was handicapped by an overvalued currency. Far from being a source of strength, the gold standard during the twenties did not provide the means to avoid economic catastrophe; it gave weaker economies no protection once crisis came

THE FIRST SHOCK: 1928–1930

In early 1928 the Fed moved to curb growing stock market speculation by introducing a tight money policy. As interest rates rose, Fed officials believed that borrowing for speculative purposes would become too expensive and the furious buying would fade away. This strategy was a complete failure. It did, however, have serious repercussions for international lending because it altered the relationship between U.S. interest rates and those in the rest of the world. Since 1924 the Fed had kept rates low in order to encourage U.S. money to flow overseas, and many economies had become highly dependent on the continuation of the flow. However, borrowers began to see that much of the international capital was short term and highly volatile. Indeed the term "hot money" had been coined to describe its chief characteristic. Responding to higher interest rates, U.S. savers decided that the domestic opportunities had become so attractive that money which previously would have been sent overseas remained at home. But the United States was the world's leading international investor during the 1920s, with central Europe and Latin America being especially favored. How could international borrowers entice Americans to send more capital to them?

An obvious response for the borrowing countries was to raise interest rates themselves and preserve their relative appeal to the international investor. Many did just that, but the imposition of even higher rates of interest was not without its cost. For countries moving into recession, the imposition of a restrictive monetary policy would accelerate the economic decline. For example, in Germany the economy had reached a peak in 1927 and had already begun to contract when the supply of U.S. capital, on which rising German living standards relied, became less certain. All countries trying to attract international capital had to reject economic plans that would cause a budget deficit. International lenders became alarmed when policies they judged imprudent were introduced, but with tax receipts falling and legitimate claims for relief rising, maintaining a balanced budget was very difficult. Unfortunately, the gold standard restricted the freedom of nations to implement expansive economic policies that might counteract the effect of severe depressions.

After the Stock Market Crash in October 1929, the Fed reduced interest rates, and for a short while international lending recovered. However, this revival was a false dawn. In the middle of 1929 the U.S. economy had reached a cyclical peak and began to contract rapidly. At the same time there was a sharp fall in international foodstuff and raw material prices, which was serious for primary product nations as it lowered the value of their exports relative to imports and quickly led to balance of payments deficits. Most primary producing countries were in debt and deflation increased the real burden. In other words, more pounds of coffee or tons of copper had to be exported to pay off interest charges on the debts already accumulated. Nor was there any easy way to check falling prices. In fact, sometimes the response of producers to deflation was to produce more, which only compounded the problem.

As the economies of major industrial powers, such as Germany, Great Britain and the United States, deteriorated, their purchases of imports declined. Primary product countries now faced a twofold problem. First their exports could not find markets even at very low prices; second, it was becoming increasingly difficult to attract foreign capital. In these circumstances nations were forced to cut imports. Countries reacted by increasingly desperate measures, such as the introduction of tariffs and quotas and the production of import substitutes. As one country's imports are another's exports, this move only shifted the problem and invited retaliatory action.

The use of tariff increases was not confined to debtor nations. In 1930 Congress approved and, in spite of the appeals of hundreds of economists, President Hoover refused to veto the Hawley-Smoot tariff. The decision to raise duties on U.S. imports was one of narrow self-interest; policy makers failed to understand the need for debtor countries to earn dollars by selling goods to the United States. Although Hawley-Smoot invited and received retaliation, it would be a mistake to view this legislation as playing more than a minor role in reducing international trade. Growing depression and contracting income explain the decline in the purchase of internationally traded goods.


After two years of depression, financial institutions in many countries were in a highly vulnerable position. Moreover, such was the intensity of the economic collapse that new international lending had virtually ceased.

The failure of Austria's largest bank, the Credit Anstalt, in the spring of 1931, rang alarm bells. The Austrian government had conscientiously followed the rules of the gold standard but had not been able to fight off the crisis. Calls for help to the international financial community had generated only modest assistance. In July 1931, a crisis of confidence enveloped the German banking system. Since the first signs of depression, the German government had been rigorously deflating the economy, doing so at enormous social cost as unemployment mounted and serious political unrest began to attract international attention. German banks had a large amount of foreign debt, about forty percent of which was American. To ease the strain on German banks, President Hoover unilaterally proposed a moratorium on all inter-governmental debts.

The Hoover Moratorium suspended war debts and reparations payments for one year but expected the repayment of private debts to U.S. citizens to continue. The Germans were delighted with this initiative, but the French, who had not been consulted, were furious, suspecting that this action spelled the end of reparations payments. Unfortunately the Moratorium did not halt the assault on the banking system. As the uncertainty increased, those Germans and Americans who could shift their money out of marks into gold or currencies less at risk of devaluation did so quickly, thus making the threat of devaluation even more likely. Who could help Germany?

The United States felt that with the Hoover Moratorium it had done enough. Great Britain, low on gold reserves, could offer no more than minor assistance. France had accumulated a massive gold stock but insisted on attaching political conditions to assistance that Germany found unacceptable. In the summer of 1931, Germany introduced exchange controls and froze foreign-owned credits, making it impossible for U.S. citizens to withdraw their capital. This action was a stark warning to holders of foreign currency everywhere. The mark was not devalued, but severe deflation and import controls became even more draconian. As a result, unemployment rose, farm income plummeted, and Communists battled for political control with fascists.

As the crisis gathered pace in Germany, investors became increasingly anxious about sterling, widely considered overvalued. Britain's highly publicized budget and balance of payments deficits intensified anxieties, as did the presence of a new Labour government. The orthodox deflationary policies imposed by the country's first socialist government were in vain. The Bank of England did not have sufficient reserves to withstand the persistent selling of sterling, and in September 1931 Britain devalued the pound and became the first major country to leave the gold standard. Virtually all the countries that had strong trading links with Britain quickly followed London's example and cut their links with gold. Investors everywhere saw this action as a warning that no currency was safe from devaluation. It is important to remember that Britain was forced to abandon gold and did not take this action as part of a measured policy initiative. It is also significant that Britain, and the other economies that cut themselves free from the shackles of the gold standard, soon showed signs of a rapid recovery from the Depression.

The reaction of many countries that had close trading links with Britain was to abandon gold and devalue their currencies, too. However, once devalued, sterling was considered safe. Speculators turned away from London and made an assessment of the next most vulnerable currency. They quickly concluded that it was the U.S. dollar.

Once the speculators began to attack the dollar, the Fed moved quickly to protect the external value of the currency by instituting a tight money policy. Raising interest rates was the appropriate course of action for a defense of the currency, but unfortunately it was exactly the wrong policy for the beleaguered banking system. However, the Fed wanted to send a strong signal to speculators that defending the dollar was a priority. Sadly, at the same time an already serious depression was made even worse by a cluster of bank failures which required an easy money policy if the Fed was to render central bank assistance to distressed bankers and depositors. After a while speculation eased but returned with a vengeance during the winter of 1932 and 1933. Again the Fed raised interest rates to defend the dollar, and by March 1933 virtually every state had closed its banks.


The gold standard, which was held in awe, was supposed to guarantee stability. It imposed a set of rules on participating economies, and the adjustments required to maintain equilibrium were supposed to minimize economic fluctuations. But the gold standard did not work in that way. During the 1920s, France and the United States acquired the bulk of the world's gold stock but chose to sterilize it rather than let it increase the money supply. The latter course of action would have introduced inflationary pressures, made their exports more expensive, and eventually have led to a loss of gold that would have benefitted the nations which received it. Apart from France and the United States, many gold standard countries lived on the margin with inadequate reserves. Once these countries began losing gold they had limited choices. They were forced to deflate their economies, so that their exports became more competitive, and cut back on imports in order to reduce gold losses. But deflationary policies raised unemployment, increased business failures, and lessened the demand for someone else's exports. International borrowing, which had been a useful way of avoiding the full rigors of deflation in the past, was not a possibility after the middle of 1930 when nervous investors began to repatriate their funds—and with great speed once the first payment defaults added to the anxiety. Even in robust democracies such as Great Britain, deflation imposed evident strains. In other nations, breaking the backs of the people was eventually viewed as a cure worse than the disease. Default, or devaluation, seemed preferable. Even during this deflationary spiral, many policy makers and members of the public associated devaluation with damaging inflation. Reducing the external value of the currency was a weapon of last resort in societies with recent experience of destabilizing price rises. Devaluation had also the disadvantage of antagonizing international investors, but this disincentive was no longer powerful once there was no international capital to attract. Countries that devalued gained a competitive advantage for their exports, but in doing so they put an even greater strain on nations that strove to maintain the external value of their currencies. Sometimes competitive, or "beggar-thy-neighbor," devaluations took place with countries striving to stay ahead of the game. Those who declined to devalue, responded with increased tariffs and quotas or the imposition of exchange controls.

The depression was transmitted through foreign trade, and the United States was at the heart of the contraction. The supply of dollars to the rest of the world, which resulted both from American overseas lending and payment for U.S. imports, fell drastically from $7.4 billion in 1929 to $2.4 billion in 1932. The growing shortage of dollars became a serious problem. Once Debtor countries used up their meagre reserves, they had to take steps to cut their imports. Unfortunately, in doing so they helped to export the Depression. Primary producing nations found that the prices of their exports fell far more steeply than the prices of the manufactured goods that they wished to import. In Europe, the inter-related war debts and reparations were fundamentally destabilizing. Unfortunately, the gold standard functioned as a mechanism for spreading the Depression rather than containing it.

In April 1933, Roosevelt, who was less committed to orthodoxy than Hoover, devalued the dollar and the U.S. abandoned the gold standard. The president was clearly signalling his intention to put domestic recovery to the fore. The aim of devaluation was to stimulate the U.S. economy and it was an essential prerequisite for New Deal policies designed to raise export-oriented farm prices. Indeed, the devaluation of the dollar was welcomed by farmers who also hoped that some beneficial inflation of farm prices would follow.

In 1931, forty-seven countries embraced the gold standard. By late 1933 only a small rump comprising, principally, Belgium, France, the Netherlands and Switzerland still clung to the old orthodoxy. To remain competitive the "gold bloc" nations had to resort to savage deflation, which imposed serious social costs on their populations. As their economies declined their currencies came under severe speculative pressure, to which the orthodox solution was even more deflation and protection. However, raising tariff barriers was not a solution since countries that had already devalued their currencies also used tariffs as a retaliatory device.

By 1936, Germany no longer paid reparations, and Britain and France ignored their war debt payments to the United States. In that year, 77 percent of Latin American loans were in default—for Chile and Peru the figure was 100 percent. September 1936 also marked the demise of the gold standard as France, the Netherlands and Swizerland were forced to concede that the cost of staying on gold far outweighed any possible advantages. With this round of devaluations, the governments of these countries had more freedom to address the formidable economic problems that loyalty to the gold standard had intensified.

As Eichengreen shows, the countries that followed Britain off gold in 1931 managed to avoid the worst effects of the Depression. However, although devaluation presented policy makers with the opportunity to implement vigorous recovery policies, few nations embraced expansionary fiscal and monetary initiatives. Caution prevailed, and although the abandonment of the gold standard, together with devaluation, was essential for economic recovery, the subsequent expansion was often disappointingly weak.

During World War II, commentators became convinced that the selfish economic nationalism that characterized the 1930s had played a key role in exacerbating the international tensions that ultimately led to armed conflict. War debts and reparations, inadequate international co-operation and the absence of international institutions that could assist economies in trouble all helped to make the prewar decade so troubled. The Bretton Woods Agreement (1944) sought to correct the deficiencies of the 1930s by setting up two new institutions. They were the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development, which became known as the World Bank. These institutions were designed to provide an effective structure for international co-operation and to render unnecessary the "beggar-thyneighbor" policies that proved so destabilizing before 1939.



Eichengreen, Barry. Golden Fetters: The Gold Standard and the Great Depression, 1919–1939. 1992.

Eichengreen, Barry. "Twentieth–Century U.S. Foreign Financial Relations." In The Cambridge Economic History of the United States, Vol. 111: The Twentieth Century, edited by Stanley L. Engerman and Robert E. Gallman. 2000.

Foreman-Peck, James. A History of the World Economy. International Economic Relations since 1850. 1983.

James, Harold. The German Slump: Politics and Economics, 1924–1936. 1985.

Kindleberger, Charles P. The World in Depression, 1929–1939. 1973.

McNeil, William, C. American Money and the Weimar Republic. 1986.

Schuker, Stephen A. American "Reparations" to Germany, 1919–1933: Implications for the Third-World Debt Crisis. 1988.

Temin, Peter. Lessons from the Great Depression. 1989.

Peter Fearon

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International Impact of the Great Depression

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International Impact of the Great Depression