2. Why was there a Great Depression in the 1930s?
Many textbooks simply link the Great Crash and the Great Depression together - what caused the Great Crash is assumed to have caused the Great Depression which followed it.
Actually there was no reason why a stock market crash need have caused the Depression, so economists have tried to find reasons why the Crash slid into Depression. Their explanations are VERY complicated and theoretical, but some of their main ideas (MUCH simplified) are:
1. Explanations at the time
a. Basically, at the time, people hadn’t a clue what had caused the depression. Herbert Hoover argued that it was the European financial collapse of 1931 that turned it into the Depression; (so it was Europe’s fault, not America’s).
b. The explanation of British economist John Maynard Keynes in 1936, who wrote General Theory of Employment, Interest, and Money, was that the cause was a DROP IN SPENDING, caused by people saving too much. This was certainly what Roosevelt believed, and his answer was simply to pump money into the US economy; increased spending, however, did not cure the Depression.
2. Great Crash
a. You will often hear it said that the Great Crash didn’t cause the Great Depression. There were only 1.5 million shareholders, and only 600,000 speculators – so why should their misfortune cause a Depression in a country of 123 million?
b. However, you will remember that much of the bull market had been financed by loans – in 1929 brokers’ loans amounted to $8.5 billion. Much of this money had been advanced by the banks, and by the big companies (in 1929, 200 companies controlled half of US industry). So when the speculators crashed, many banks went bankrupt, and half of US businesses was damaged, so the whole US economy suffered.
3. The Fed
a. (‘The Fed’ was the US Federal Reserve – the American ‘Bank of England’.)
In the 1940s, Milton Friedman came up with a theory about the cause called ‘monetarism’ – he believed that price changes were caused by a reduction of money in the economy. He therefore blamed the US Federal Reserve which in 1931 raised interest rates – which, he claimed, led to a reduction in the money supply. His famous saying was that ‘the Fed put the Great in the Great Depression’.
b. This was made worse, Friedman added, when the banks began to go bankrupt after 1931, and because the amount of money in the economy was linked to the Gold Standard (meaning that the government would only issue as much money as it could redeem in gold).
a. In 1930, fearing for the US economy, the government passed the Smoot-Hawley Tariff – a new, even heavier tariff law.
b. Sixty countries passed retaliatory tariffs in response and world trade slumped. This damaged US industry, especially agriculture.
5. Maldistribution of wealth
a. Nowadays, historians think that a major cause of the depression was the inequality of wealth in America. There were some extremely rich people, and huge numbers of extremely poor people – the top 5% owned a third of the wealth, while 40 per cent of the population were living in poverty.
b. It wasn’t that there was too little money, but it wasn’t in the hands of the people who would spend it. Consequently, Americans produced too much and bought too little, and prices plummeted.
6. Weaknesses in the economy
You will remember that Agriculture, and the Coal, Iron and Textiles industries were all experiencing problems in the 1920s. When the Depression started, they were not strong enough to cope, and collapsed quickly.
7. Cycle of Depression
As more banks and companies failed, and people were put out of work, they had less to spend, and so more companies went bankrupt and made their workers unemployed etc. Once the Depression had taken hold, it simply spiralled down worse and worse.