THE GREAT DEPRESSION

1929-1940

The Economic Consequences of the War

Britain, France and Germany all suffered economic upheaval from the war.

The US benefitted greatly from the war. Currency – in the form of gold – flooded into the US.

Britain, France and Germany all used inflation to pay for the war. Had trouble re-establishing the worth of their money.

Reparations meant the worth of Germany’s currency plummeted (i.e. inflated absurdly).

In America

After the war, there was a recession, especially in farm prices. American farmers had taken on debt during the war, now they couldn’t pay it back (deflation).

By 1923, the economy was growing because of increased productivity and the abundance of gold at the federal reserve. (Cheap money)

In 1927, in order to help the Bank of England, the Fed dropped interest rates, helping spark a stock market bubble in the US because it was cheaper to borrow money.

Tariff Policies The Fordney-McCumber tariff (1922) raised

rates just as European countries needed to sell in the US to recover from WWI.

Trade wars slowed down international trade, contributing to glutting the market.

Agricultural prices were hit the hardest. Smoot-Hawley (1930) was designed to

protect American business, but only accelerated the breakdown in trade and the glutting of markets.

Falling prices kept the downward cycle going.

Overproduction

A recession in many industries predated the stock market crash.

The recession – especially in agriculture - was caused mainly by a glutted market and excess production capacity.

Productivity had outpaced the ability of most people to buy things (uneven distribution of wealth and income).

Easy credit and relatively cheap money helped keep the economy chugging along, but set the stage for the market crash.

The Feedback Loop

People without disposable income

stop consuming

Sales decline and producers lay off workers

Laid off workers can’t

consume

Psychological toll

As wealth and income declined, people stopped buying. This exacerbated the feedback loop.

Long term unemployment was psychologically crippling for most, especially for husbands / fathers who had been “breadwinners”.

Birth rates declined, social mobility slowed.

Decline in private investment

Overconfidence America’s great reserves of gold

(accumulated during World War I) and the presence of the new Federal Reserve created a sense that the economy was impervious to the shocks of previous eras.

Many spoke of a “new economy” that did not behave as the old economy had, and a “new prosperity” that meant “wealth for all.”

Most of the wealth went to the top of the economic ladder, i.e. the people making economic decisions. They were unaware of the hardship down the economic ladder in the ’20s.

The Stock Market Bubble

Money poured into the stock market from private and institutional investors. The Dow Jones went from 63.9 in the middle of 1921 to 381.1 before the Crash.

The stock bubble sucked in money from around the country and around the world.

Money that had been propping up the Dawes plan went to the stock market and Germany entered a recession.

While the US boomed, the Gold Standard crippled other economies with deflation.

The Market Crash, Fall 1929

A British financier’s accounts collapsed in fraud. The Bank of England raised its rates.

British investors had to pull out of the US stock market to protect their balance sheets.

The market crashes a little and gets “wobbly”.

10-23-29, the first great sell-off. Over the next few days, the market

plummets as everyone tries to get their money out and cover their margins (loans).

The Market

The Banking Crisis US banks had always been prone to failures (i.e.

when they cannot pay their financial obligations). This was especially true of small banks.

The Stock Market Crash put great strain on banks that had lent money to speculators and in some cases also invested in the market.

Banks lent $9 for every $1 an investor put forth. When stocks collapsed, few could pay back their

loans to banks. Banks became insolvent and failed. People lost their savings, which meant less

spending. Banks stopped lending, which meant fewer jobs.

Bank failures

The Gold Standard

For various reasons, by 1930, 60% of the world’s gold was in the US and France.

Countries stayed on the Gold Standard, despite not having much gold.

This forced deflation, falling prices and often unemployment in countries like Britain.

Most countries abandoned the gold standard by 1934, freeing their currencies to expand.

Philosophical paralysis

U.S. Treasury SecretaryAndrew Mellon “welcomed” the hard times as “building moral character.”

Hoover believed in “rugged individualism”. While he did move to increase public spending, he was adamantly opposed to direct aid to the public.

The ghost of Grover Cleveland: “The people should support the government, the government should not support the people.”

General Law of Demand

Demand = Consumer Spending + Business Investment + Government Spending + Exports-Imports

If consumers stop spending and businesses stop investing in new plants, where will demand come from?

The equation suggest government spending – which is what Hoover and FDR tried.

World War II ultimately boosted government spending and business investment.

Cascade of Comparative Crises US constricting German credit

(1928)=Mexican peso crisis (1994) US Stock Market Crash (1929)=Market

Crash (2000) Banking Crisis (1931-33) = Financial

Crisis (2008-2009) European Financial Crisis (1931) =

Emerging market “contagion” (1997-98) Today we have had more time between

crises and better policies to meet them.