What caused the great depression?

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Below is a term project I did on history about the Great Depression. In it you will find what the great depression was all about, the causes and its consequences. This assignment helped to enlighten my view and gave me more inside on the Great Depression.


The Great Depression was an economic slump in North America, Europe, and other industrialized areas of the world that began in 1929 and lasted until about 1939. It was the longest and most severe depression ever experienced by the industrialized Western world. Although the Depression originated in the United States, it resulted in drastic declines in output, severe unemployment, and acute deflation in almost every country of the globe.

The Great Depression began in the United States but quickly turned into a worldwide economic slump owing to the special and intimate relationships that had been forged between the United States and European economies after World War I. The United States had emerged from the war as the major creditor and financier of postwar Europe, whose national economy had been greatly weakened by the war itself, by war debts, and, in the case of Germany and the other defeated nations, by the need to pay war reparations. So once the American economy slumped and the flow of American investment credits to Europe dried up, prosperity tended to collapse there as well. The Depression hit hardest those nations that were most deeply indebted to the United States, that is Germany and Great Britain. In Germany, unemployment rose sharply beginning in late 1929 and by early 1932 it had reached 6 million workers, or 25 percent of the work force. Britain was less severely affected, but its industrial and export sectors remained seriously depressed until World War II. Many other countries had been affected by the slump by 1931. Almost all nations sought to protect their domestic production by imposing tariffs, raising existing ones, and setting quotas on foreign imports. The effect of these restrictive measures was to greatly reduce the volume of international trade. By 1932 the total value of world trade had fallen by more than half as country after country took measures against the importation of foreign goods.

The timing and severity of the Great Depression varied substantially across countries.

The Depression was particularly long and severe in the United States and Europe; it was milder

in Japan and much of Latin America. Perhaps not surprisingly, the worst depression ever

experienced stemmed from a multitude of causes. Declines in consumer demand, financial

panics, and misguided government policies caused economic output to fall in the United States.

The gold standard, which linked nearly all the countries of the world in a network of fixed

currency exchange rates, played a key role in transmitting the American downturn to other

countries. The recovery from the Great Depression was spurred largely by the abandonment of

the gold standard and the ensuing monetary expansion. The Great Depression brought about fundamental changes in economic institutions, macroeconomic policy, and economic theory.

In the United States, the Great Depression began in the summer of 1929. The downturn

became markedly worse in late 1929 and continued until early 1933. Real output and prices fell

precipitously. Between the peak and the trough of the downturn, industrial production in the

United States declined by 47 percent and real gross domestic product fell by 30 percent. The wholesale price index declined by 33 percent which is known as deflation. The timing and severity of the Great Depression varied substantially across countries. Great Britain struggled with low growth and recession during most of the second half of the 1920s, due largely to its decision in 1925 to return to the gold standard with an overvalued pound. Britain did not slip into severe depression, however, until early 1930, and the peak-to-trough decline in industrial production was roughly one-third that of the United States. France also experienced a relatively short downturn in the early 1930s. The French recovered in 1932 and 1933, however, it was short-lived. French industrial production and prices both fell substantially between 1933 and 1936. Germany’s economy slipped into a downturn early in 1928 and then stabilized before turning down again in the third quarter of 1929. The decline in Germany’s industrial production was roughly equal to that in the United States. A number of countries in Latin America slipped into depression in late 1928 and early 1929, slightly before the U.S. decline in output. While some less developed countries experienced severe depressions, others, such as Argentina and Brazil, experienced comparatively mild downturns. The depression in Japan started relatively late (in the early 1930s) and was, by comparison, milder.

The general price deflation evident in the United States was also present in other

countries. Virtually every industrialized country endured declines in wholesale prices of 30

percent or more between 1929 and 1933. Because of the greater flexibility of the Japanese price

structure, deflation in Japan was unusually rapid in 1930 and 1931. This rapid deflation may

have helped to keep the decline in Japanese production relatively milder. The prices of primary

commodities traded in the world market declined even more dramatically during this period. For

example, the prices of coffee, cotton, silk, and rubber were reduced by roughly half just between

September 1929 and December 1930. As a result, the terms of trade declined precipitously for

producers of primary commodities.

The U.S. recovery began in the spring of 1933. Output grew rapidly in the mid-1930s that is the real gross domestic product rose at an average rate of 9 percent between the year 1933 and 1937. Output had fallen so deeply in the earlier years of the 1930s, however, it remained substantially below its long run trend level throughout this period. In 1937–38 the United States suffered another severe downturn, but after mid-1938 the American economy grew even more rapidly than in the mid-1930s. U.S. output finally returned to its long-run trend level in 1942.

Recovery in the rest of the world varied greatly. The British economy stopped declining

soon after Britain’s abandonment of the gold standard in September 1931, though genuine

recovery did not begin until the end of 1932. The economies of a number of Latin American

countries began to strengthen in late 1931 and early 1932. Germany and Japan both began to

recover in the fall of 1932. Canada and many smaller European countries started to revive at

about the same time as the United States, early in 1933. On the other hand, France, which

experienced severe depression later than most countries, did not firmly enter the recovery phase until 1938.

There were causes as well as impacts of the Great Depression. The fundamental cause of the Great Depression in the United States was a decline in spending which led to a decline in production as manufacturers and merchandisers noticed an unintended rise in inventories. The sources of the contraction in spending in the United States varied over the course of the Depression, but they cumulated into a monumental decline in aggregate demand. The American decline was transmitted to the rest of the world largely through the gold standard. However, a variety of other factors also influenced the downturn in various countries.

Another great cause was the crash of the stock market. The initial decline in output in the United States in the summer of 1929 is widely believed to have stemmed from tight U.S. monetary policy aimed at limiting stock market speculation. The 1920s had been a prosperous decade, but not an exceptional boom period, wholesale goods prices had remained nearly constant throughout the decade and there had been mild recessions in both 1924 and 1927. The one obvious area of excess was the stock market. Stock prices had risen more than fourfold from the low in 1921 to the peak 1929. In 1928 and 1929, the Federal Reserve had raised interest rates in hopes of slowing the rapid rise in stock prices. These higher interest rates depressed interest-sensitive spending in areas such as construction and automobile purchases, which in turn reduced production. Some scholars believe that a boom in housing construction in the mid-1920s led to an excess supply of housing and a particularly large drop in construction in 1928 and 1929. By the fall of 1929, U.S. stock prices had reached levels that could not be justified by reasonable anticipations of future earnings. As a result, when a variety of minor events led to gradual price declines in October 1929, investors lost confidence and the stock market bubble burst. Panic selling began on “Black Thursday,” October 24, 1929. Many stocks had been purchased on margin that is, using loans secured by only a small fraction of the stocks’ value. As a result, the price decline forced some investors to liquidate their holdings, thus exacerbating the fall in prices. Between their peak in September and their low in November, U.S. stock prices declined by 33 percent. Because the decline was so dramatic, this event is often referred to as the Great Crash of 1929. The stock market crash reduced American aggregate demand substantially. Consumer purchases of durable goods and business investment fell sharply after the crash. A likely explanation is that the financial crisis generated considerable uncertainty about future income, which in turn led consumers and firms to put off purchases of durable goods. Although the loss of wealth caused by the decline in stock prices was relatively small, the crash may also have depressed spending by making people feel poorer. As a result of the drastic decline in consumer and firm spending, real output in the United States, which had been declining slowly up to this point, fell rapidly in late 1929 and throughout 1930. Thus, while the Great Crash of the stock market and the Great Depression are two quite separate events, the decline in stock prices was one factor causing the decline in production and employment in the United States.

The next blow to aggregate demand occurred in the fall of 1930, when the first of four

waves of banking panics gripped the United States. A banking panic arises when many

depositors lose confidence in the solvency of banks and simultaneously demand their deposits to be paid to them in cash. Banks, which typically hold only a fraction of deposits as cash reserves,

must liquidate loans in order to raise the required cash. This process of hasty liquidation can

cause even a previously solvent bank to fail. The United States experienced widespread banking

panics in the fall of 1930, the spring of 1931, the fall of 1931, and the fall of 1932. The final

wave of panics continued through the winter of 1933 and culminated in the national “bank

holiday” declared by President Franklin Roosevelt on March 6, 1933. The bank holiday closed

all banks, permitting them to reopen only after being deemed solvent by government inspectors.

The panics took a severe toll on the American banking system. Once the stock market crashed, fearful that banks would fail, millions of Americans began to withdraw their money. Virtually overnight, they put thousands of banks in peril. The more money Americans withdrew, the more banks failed, and the more banks failed, the more money Americans withdrew. By 1933, more than 11,000 of the nation’s 25,000 banks had collapsed.

Moreover another leading cause was the reduction in purchasing across the board. With the stock market crash and the fears of further economic woes, individuals from all classes stopped purchasing items. This then led to a reduction in the number of items produced and thus a reduction in the workforce. As people lost their jobs, they were unable to keep up with paying for items they had bought through installment plans and their items were repossessed. More and more inventory began to accumulate. The unemployment rate rose above 25% which meant, of course, even less spending to help alleviate the economic situation.

In addition the creating of the American Economic policy with Europe was another factor. As businesses began failing, the government created the Smoot-Hawley Tariff in 1930 to help protect American companies. This charged a high tax for imports thereby leading to less trade between America and foreign countries along with some economic retaliation.

Lastly the drought conditions, while not a direct cause of the Great Depression, the drought that occurred in the Mississippi Valley in 1930 was of such proportions that many could not even pay their taxes or other debts and had to sell their farms for no profit which led to a further worsening of economic conditions.

The great depression itself had a devastating impact on the economy. The most obvious economic impact of the great depression was human suffering. In a short period of time world output and standards of living dropped precipitously. As much as one fourth of the labor force in industrialized countries was unable to find work in the early 1930s. While conditions began to improve by the mid 1930s, total recovery was not accomplished until the end of the decade.

The Depression had profound political implication. In countries such as Germany and Japan, reaction to the Depression brought about the rise to power of militarist governments who adopted the regressive foreign policies that led to the Second World War. In countries such as the United States and Britain, government intervention ultimately resulted in the creation of welfare systems and the managed economies of the period following the Second World War.

In the United States Roosevelt became President in 1933 and promised a "New Deal" under which the government would intervene to reduce unemployment by work-creation schemes such as street cleaning and the painting of post offices. Both agriculture and industry were supported by policies (which turned out to be mistaken) to restrict output and increase prices. The most durable legacy of the New Deal was the great public works projects such as the Hoover Dam and the introduction by the Tennessee Valley Authority of flood control, electric power, fertilizer, and even education to a depressed agricultural region in the south.

The New Deal was not, in the main, an early example of economic management, and it did not lead to rapid recovery. Income per capita was no higher in 1939 than in 1929, although the government’s welfare and public works policies did benefit many of the most needy people. The big growth in the US economy was, in fact, due to rearmament.

In Germany, Hitler adopted policies that were more interventionist, developing a massive work-creation scheme that had largely eradicated unemployment by 1936. In the same year rearmament, paid for by government borrowing, started in earnest. In order to keep down inflation, consumption was restricted by rationing and trade controls. By 1939 the Germans’ Gross National Product was 51 percent higher than in 1929 — an increase due mainly to the manufacture of armaments and machinery.

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