Great Depression, Causes of (Issue)

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GREAT DEPRESSION, CAUSES OF (ISSUE)


After the presidential election of Herbert C. Hoover, (192933) in November, 1928, it seemed that all was well in the United States. The economy was prosperous and the stock market was booming. The President had promised that economic gains would continue and that poverty would disappear. Most people believed Hoover and they looked forward to a bright future. But already there were signs that the economic system was not as sound as it appeared to besoon the great collapse began.

The most crucial barrier to U.S. economic health was the unstable character of the international economy following World War I (19141918). Before World War I the United States had been a debtor nation, but between 1914 and 1919 there was a major change. The United States had become the world's leading creditor; the war also propelled most of Europe's economies into a state of collapse and they could not pay their debts. By the end of the war the private debt owed by Europeans to the United States equaled nearly $3 billion, and the public debt owed by foreign governments to the U.S. government was $10.3 billion.

To deal with this potentially disastrous situation the United States could have forgiven public debts and adopted a trade policy designed to encourage exchange, but the policy that was followed was exactly the opposite. The United States demanded that foreign governments pay their debts in full. At the same time, the United States raised tariff rates, which undermined trade. This resulted in a favorable balance of trade for the United States and an increasing trade deficit for Europe. It was only because of massive investments by U.S. businesses, which amounted to about $1 billion per year between 1919 and 1930, that Europe was able to make up the deficit. Thus the international financial structure came to be almost entirely dependent upon U.S. businesses and banks. This European reliance on U.S. investments was a system that could operate successfully only as long as the outflow of U.S. capital continued.

The perpetuation of such a system required that the U.S. economy remained healthy and, although it appeared to be robust, there were critical problems. The agricultural sector of the economy had never fully recovered from the recession of 19211922 and the industry operated at a net loss throughout the balance of the 1920s. When crops yielded precipitously declining prices in 1929, economic sectors that were linked to farming suffered similar losses.

Another critical problem was a longstanding maldistribution of income. By 1929 a substantial 26 percent of national income went to only two percent of income receivers. Moreover businesses tended to plow enormous portions of their profits into expansion and to increase wages at a lower rate than the economy demanded. This led to overproduction and a dangerous rise in consumer credit. (During the twenties, to purchase consumer goods, real estate, and automobiles, people went more deeply into debt than ever before.) Thus an economic scenario evolved that could only last as long as there was continued growth. Unfortunately, the growth of the period had a fragile base.

The unrealistic and unstable nature of the U.S. economy was evident in the stock market's behavior during the late 1920s. Between 1927 and 1929 trading on the stock market increased sharply and prices soared. Referred to as a "bull market," it was characterized by rigorous buying and sellingnot necessarily for long-term investment, but to make a quick profit while prices continued to rise. This type of speculation was very dangerous because it was often accomplished using borrowed money. In 1927 alone, brokers' loans using the stocks themselves for collateralincreased from $3 billion to $4.5 billion, while the volume of shares traded increased from 451 million to 577 million. This behavior drove stock prices up, far beyond any realistic connection to the value of the businesses the stocks represented. By early 1929, for example, many share issues were selling at more than sixteen times their earnings whereas the safe maximum ratio was said to be 10 to one. Between 1925 and 1929 the average price of common stock increased some 300 percent and the volume of trade more than doubled. Bank loans that were used to finance speculation rose during the same period from $3.5 billion to $8.5 billion.

Exactly why this irrational boom of borrowing and trading took place is hard to explain. Part of the blame lay with businesses that continued to produce even after there were signs that the market for their products was becoming saturated. Blame also lay with the banking community for making enormous unsound loans, and with the investors themselves who were greedy for profit. Another contributing factor might have been the fact that there were few government regulations over business, the stock trade, and banking in the period preceding the market boom and during the subsequent collapse.

By the summer of 1929 the system was out of control and stock prices had reached levels that could not be maintained. The market collapse began in September 1929, when the Bank of England raised interest rates, pushing bank clients to withdraw several hundred million dollars from New York banks. This caused stock prices to falter slightly and large investors began to unload some of their holdings quietly. Then on October 24, 1929, panic seized the stock market. On that day, known as "Black Thursday," 12 million shares were exchanged and stock prices collapsed. Business and government leaders reassured the public that this catastrophe represented only a "market adjustment" and for a few days conditions stabilized. Then on October 29, the bottom fell out again. Following this the market entered a long period of general decline that seemed to represent the virtual collapse of the financial system.

The prosperity of the twenties was dependent upon the smooth inter-working of world trade, domestic capital investment, the construction industry, and manufacturingespecially of automobiles. The key ingredient in this mix was confidence that goods could be sold and that investments would yield profits. The stock market crash severely weakened the confidence of the business community, causing purchases to decline and foreign investments to dwindle. This, in turn, led the already rickety European economy to collapse, putting an even greater strain on U.S. businesses and banks. Thus was generated an irreversible downward economic spiral which enveloped the entire industrialized world. By 1931 the Great Depression (19291939) was in full swingthe worst of its kind in recorded history.

See also: Hoovervilles, New Deal, Stock Market Crash of 1929

FURTHER READING

Bernstein, Michael L. The Great Depression: Delayed Recovery and Economic Change in America, 19291939. Cambridge: Cambridge University Press, 1989.

Faulkner, Harold Underwood. American Economic History. New York: Harper and Row, 1964.

Friedman, Milton, and Anna Jacobson Schwartz. The Great Contraction, 19291933. Princeton, NJ: Princeton University Press, 1991.

Galbraith, John Kenneth. The Great Crash, 1929. Boston: Houghton Mifflin Company, 1997.

Garraty, John Arthur. The Great Depression: An Inquiry into the Causes, Course, and Consequences of the World Wide Depression of the 1930s, as Seen by Contemporaries and in the Light of History. New York: Doubleday Press, 1986.

Link, Arthur S. American Epoch: A History of The United States Since 1890s. New York: Alfred A. Knopf, 1955.