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Article – The Causes and History of the Great Depression

Diogo Monteiro

Financial Markets

Diogo Monteiro

Financial Markets

Starting by the fall in stock prices and culminating with the stock market crash in October 1929, “The Great Depression”, was the worst economic period in US and world history characterised by high unemployment rates, deflation, a breakdown of international trade, wholesale prices and industrial production. Some countries started to recover by the mid 1930’s but overall, most of the countries felt the negative effects of this phenomenon until the start of World War II.

Although nowadays the real causes are still widely debated, one of the main events that led to the Great Depression was the overall decline in aggregate demand, which led to a decline in production because manufacturers started to notice a rise in inventories. This resulted in an economic downturn because producers could no longer sell their production. Besides this there were a lot of speculation in Wall Street (NYSE), where everybody from millionaires to cooks, spent their savings on shares, or if they couldn’t afford it, they would buy them “on margin”, “meaning that they purchased on credit while at the same time taking out loans to pay for those shares”. They did this in hope that when they sold them, they would make the money to pay back the loans and interest and after all that still have some profit for themselves. This caused the financial markets to expand and to sell overpriced shares and by August 1929, they reached their peak. During the Summer the American economy entered in recession. Thus, on October 24th, 1929, nervous investors began selling the overvalued shares in masse causing the stock market to crash where the value of common stock and shares in the U.S. market dropped by 40 percent. A record of 12.9 million shares were traded on that day that became known as Black Thursday. Five days later another 16 million shares were traded as another wave of panic swept through Wall Street. 

Despite being a tragic event, the stock market crash does not in itself explain what had happened at the time to become known as the “The Great Depression”, words first used by President Herbert Hoover to describe the situation at the time. What made matters worse was the fact that consumers, with the stock market crash, lost confidence in the banking system, which led to a tremendous rush to the banks to withdraw the money they had put in before they lost it. Over the next few years there were four major waves of panic related to the loss of confidence in the banking and financial system, as a large number of investors started to lose confidence in the solvency of their banks and demanded deposits in cash, forcing banks to liquidate loans. This caused thousand of banks to close doors and declare bankruptcy. To make matters even worse, the Fed, an agency built precisely to prevent the bankruptcy of financial institutions, instead of bringing liquidity to the banks, did just the opposite, introducing measures such as raising interest rates, which caused a decrease in the money supply in circulation, generating a mild banking crisis that started in November 1930. 

In 1932 with the country plunged deep into the Great Depression and about 15 million people unemployed, Franklin D. Roosevelt wins the American elections. Almost all of his first actions were aimed at stabilising the American economy.

 

First, he announced the “bank holiday”, where the banks closed for 4 days and in this period Roosevelt presented the new Congress with the Emergency Banking Act. However, they could only reopen when they were deemed solvent by government inspectors. As said by the author of “Great Depression History” on HISTORY website, “During Roosevelt’s first 100 days in office, his administration passed legislation that aimed to stabilize industrial and agricultural production, create jobs and stimulate recovery.” Roosevelt, also reform the financial system creating the Federal Deposit Insurance Corporation (FDIC). This aimed to prevent abuses of the kind that led to the 1929 crash. 

Besides this, “The New Deal” was created, a set of programmes and institutions that aimed to help in the recovery from the Great Depression. Among the project’s items was massive investment in public works, investing almost US$4 billion in the construction of airports, dams, hydroelectric plants (…), generating millions of new jobs. Furthermore, cotton, wheat and corn stocks were destroyed in order to contain their prices, and prices and production were also controlled to avoid overproduction in agriculture and industry. In addition, social measures were implemented in the USA, such as setting the minimum wage, creating unemployment insurance and a retirement pension (for those over 65). Despite the recovery that the US experienced, another recession hit the US in 1937 and, despite a slight recovery the following year, this recession reversed many of the gains in production and employment that the New Deal and the measures of Roosevelt’s government had implemented, extending the effects of the great depression until the end of the decade.

As you can already see, the 1930s were a turbulent period for the world economy. This contributed to the emergence of extremist governments all over the world and in particular in Europe, and in turn in Germany with the Nazi regime. German aggression led to the outbreak of war in Europe in September 1939. Although the US maintained its neutrality, it began to focus more on strengthening its military infrastructure. In December 1941, the Japanese attack on Pearl Harbour led the US into World War II, and the country’s industries went into full production, which helped to fight the Depression’s effects. This and the large-scale army conscription across the country meant that by early 1942 unemployment was back to pre-Great Depression levels. So, you could say that by this time, the Great Depression was officially over, and the US was now worried with the new war it had just entered. 

And so, the Great Depression ends and, although the post-World War II theme did not focus on what had happened in the 1930s and the Great Depression, several lessons were learnt, such as the exit from the gold standard, the need for a more globalised and less protectionist economy, among others. But what remains one of the main lessons to be learned is never to leave the financial sector alone without some form of incisive regulation and monitoring, a lesson that came back to “attack us” almost 80 years later with the 2008 financial crisis.

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