Essay on The Causes and Consequences of the Great Depression
The Great Depression was a long-lasting economic crisis in the global economy which started in the U.S. in 1929, and later involved other countries. The Great Depression officially ended in 1940, but in reality the U.S. economy started recovering only after World War II. The Great Depression was synchronized and comprehensive and affected all the sectors of the global economy. In fact, this was the global economic crisis, however, it received its title namely due to the emotional state the society found itself in: people really plunged into a depressive state of torpor.
Huge numbers of researches are now devoted to studying the Great Depression 1929-1941 and its impact on the USA and the lives of millions of Americans. Economists, politicians and social scientists continue looking for the “black box” which could help determine the causes of the disaster. Thus, Alan Reynolds (1979, p.1416) believes that the horror of the Great Depression lies mainly in the fact that no univocal explanation was found for it. People still share the feeling that a sharp economic slowdown can happen at any time: without any warning and without any reason. This fear is nowadays often exploited as a major justification for the practically unlimited intervention of the government into the economic sphere. As a result, many scientists today also take the position of criticism over the market capitalism and support economically destructive policy of the authorities.
Further in this paper, we will critically examine social and economic causes of the Great Depression, as well as analyze its consequences through the prism of different approaches. We claim that the distortions in the economy were caused by the FRS monetary policy together with incompetent policies of the authorities, which finally led to the World War II.
Causes of the Great Depression
The beginning of the Great Depression in the US is considered October 29, 1929, the so-called “Black Tuesday.” The stock market collapsed, in one day the shares fell by 10 billion dollars, which meant the disappearance of 10 billion dollars of credit money. Because of this fall 20-25 million people in the U.S. suffered losses (Ross 1997, p.12).
According to Keynesian theory the Great Depression of 1929 in the United States occurred due to overproduction of commodities and lack of money to buy them (Rothbard 2005, p.38). Since the money was tied to gold reserve, and the amount of this metal was limited, there occurred a shortage of money, and hence the shortage of effective demand for goods and services. Further, in the chain reaction: a sharp drop in prices for goods (deflation), bankruptcy of enterprises, unemployment, protective duties on imported goods, fall of consumer demand, and a sharp drop in living standards (Rothbard 2005, p.38-39; Smiley 2002, p.32).
Before the beginning of the Great Depression the rate of the U.S. gold reserve growth was slower than the development of economy. This led to the emergence of hidden inflation, as the government printed new money for the rapid growth of the economy. Thus, as Edsforth (2000, p.12-13) states the dollar’s gold supply was undermined, the budget deficit grew, and the Federal Reserve System lowered the discount rate. The situation occurred where the growth of labor productivity in industry declined, and the amount of pseudo-money (bills, receipts, etc.) on the contrary increased, and this imbalance in the economy factually led to the “Black Tuesday” in 1929 (Cole & Ohanian 1999, p.3).
However, there is another point of view about the causes of the Great Depression. According to the Marxist approach, the Great Depression was preceded by the rapid growth of the U.S. economy. Thus, from 1917 to 1927 the U.S. national income almost tripled. Conveyor production was invented, the stock market was rapidly developing, the number of speculative trading was growing, the real estate prices were going up (McElvaine 1993, p. 27). The increase in production of goods required the increase in the money supply, but the dollar was pegged to gold (Bernstein 1987, p.22).
Another common view discussed by Marxist approach is that the responsibility for the Great Depression lies on capitalism and market economy, and only the intervention of the state led to the economic recovery of America (Reed 2010, p.1). According to this simplified approach, America was smashed and pulled into the depression by the stock market, one of the pillars of capitalism. President Herbert Hoover, a supporter of the laissez-faire principle (non-interference of the state in the economy) refused to use the tools of state power, and as a result the economic situation deteriorated. Hoover’s successor, Franklin Delano Roosevelt started the government intervention and guided the country to recovery (Smiley 2008, p. 233). The conclusion seems obvious: capitalism cannot be trusted, and the state should play an active role in the economy to save us from inevitable decline (Reed 2010, p.1).
A popular explanation of the stock market crash of 1929 is based on a criticism of using borrowed funds to buy securities. The authors of many historical studies argue that rampant speculation in shares was associated with the excessive use of leverage. But Gene Smiley (2002), an economist at the Marquette University, in his 2002 book “Rethinking the Great Depression” explains why this observation cannot be called fruitful:
By that time they had already had considerable experience in the use of leverage, and in the late 1920’s the margin requirements (the ratio of one’s own funds to loans) were not lower than in the early 1920’s or in the preceding decades. Moreover, the fall of 1928 the margin requirements began to rise, and borrowers had to pay in cash most of the cost of the purchased shares (Smiley 2008, p. 231).
So, the argument about the leverage does not hold water. However, the manipulation with money and credit flows is an absolutely different matter.
Most economists-monetarists, in particular the representatives of the Austrian school, note the close relationship between cash flow and economic activity. When the state makes cash and credit injections, interest rates fall at first. Companies invest this easy money in new projects in the production sphere and the commodity market is booming. With the stabilization of the situation, the costs of doing business rise, interest rates are adjusted upward, and profits fall. Thus, the effect of easy money comes to naught, and the monetary authorities, fearing of price inflation, slow down the money supply growth or even reduce it. In any case, these manipulations are sufficient to deprive an economic card-castle of its shaky foundation (Reed 201, p.2).
Another interesting interpretation of the actions of the Federal Reserve System before the 1929 crash can be found in the book of economist Murray Rothbard (2005) “America’s Great Depression”. Using the complex criterion, including, among other things, factors like currency, perpetual and term deposits, he calculated that from mid 1921 to mid 1929 the Fed inflated the money supply by more than 60% (Rothbard 2005, p. 89). According to Rothbard (2005), such an increase of money and credit flows led to a reduction in interest rates, brought the indexes of the stock market to unprecedented heights and created the phenomenon of the roaring twenties.
Unrestrained growth of the credit monetary mass became what the economist Benjamin Anderson called the beginning of the New Deal – the well-known interventionist policy carried out later by the President Franklin Roosevelt. However, other scientists doubt that the Fed move was the cause of inflation, and point to relatively stable prices for raw materials and consumer goods in 1920, which, in their opinion, suggests that monetary policy was not so irresponsible (Higgs 1997, p.564; Edsforth 2000, p.51).
Of course, a significant reduction of the high income tax rates under Coolidge helped the economy, and perhaps smoothed the price effect the FRS policy. The tax reduction stimulated investment and real economic growth, which further led to new technological breakthroughs and business inventions in terms of production cheapening. Undoubtedly, the booming growth of labor productivity had a stabilizing effect on prices, which would otherwise be higher (Reed 2010, p. 2-3).
Speaking about FRS’s policy, economists and market experts, who are divergent in their estimates of the scale of the FRS’s monetary expansion in the early and mid 1920’s, are unanimous as to what happened after it: at the end of the decade a sharp monetary contraction began, and the Central bank was responsible for it. The actions of federal authorities in response to the recession only led to its aggravation (Higgs 1997, p.563-64; McElvaine 1993, p. 97).
The biggest failure of Hoover’s administration was the Smoot-Hawley Tariff adopted in June 1930 (Reed 2010, p.6). It was a complement to the Fordney-McCumber Tariff of 1922, which led the American agriculture to a crisis in the previous decade. Smoot-Hawley Tariff, the most protectionist bill in the U.S. history, practically closed the borders to foreign commodities and initiated a bitter trade war (Reed 2010, p.6; McElvaine 1993, p. 56). Officials from the administration and Congress were convinced that putting trade barriers would make the Americans buy more domestic commodities and this would finally solve the unemployment problem. But they apparently did not know an important principle of international trade: the state cannot block the import without blocking the export at the same time (McElvaine 1993, p. 74).
In general, the distortions in the economy caused by the FRS monetary policy led the country to the path of recession, but the further steps of the state turned a recession into a full scale disaster. Thus while the quotes were collapsing, Congress was playing with fire: for example, on the “Black Thursday” morning the newspaper reported that in the Capitol the forces supporting the increased fees for transactions in securities prevailed.
Roosevelt’s New Deal
In turn, Roosevelt, indeed, made some changes, but they were apparently not the changes the country hoped for. In his first hundred days he took severe measures to limit profits. Instead of removing the barriers to the growth of wealth erected by his predecessor, he created his own ones. He weakened the U.S. dollar in every way through increase of its quantity and worsening of its quality. He confiscated the gold from the population, and after that depreciated the dollar by 40%.
Roosevelt’s idea to close the banks and on March 6 declare the bank holidays (which actually finished in only nine days) is still admired by his advocates calling it a decisive and necessary step. However, more than 5,000 banks working at the time of announcing the holidays did not open after their completion, and 2,000 of them closed forever, according to Friedman and Schwartz (Friedman & Schwartz, cited in Bordo 1989, p. 29). Almost all the bankrupted banks had worked in the states with branchless system laws (these laws prohibited banks to open branches and thereby diversify their portfolios and reduce risks). While in the United States with their branchless system laws thousands of banks went bankrupt, in Canada where bank branches were allowed not a single bankruptcy was recorded (Anari, Kolari & Mason 2005, p. 756).
In 1935, Roosevelt persuaded the Congress to establish a Social Security system, and in 1938 to introduce the minimum wage for the first time in the history of the country. Although the general public still puts these measures to his credit, many economists have another point of view. As a result of the introduction of the minimum wage, many inexperienced, young, unskilled and vulnerable workers became too expensive for the employer (according to some estimates, the provisions on minimum wage adopted in 1933 under another law, left unemployed about 500,000 African Americans) (Smiley 2008, p.234; Higgs 1997; p. 574). And current researches and evaluations show that the Social Security system has evolved in such a nightmare that it will be necessary either to privatize it, or raise the already high taxes to keep it afloat (Edsforth 2000, p. 79).
In general, as a result of his efforts, the economy was depressed till the end of the decade. Moreover, many scientists now agree that the New Deal not only did not put an end to the FRS’s follies, but even extended the Great Depression.
Consequences of the Great Depression
The Great Depression had important consequences both for the U.S. economy and the global economy as a whole.
In the U.S., the consequences were the following: a large number of banks closed, there was deflation and real estate prices collapsed, the industrial production reduced by 2 times, the harvest of cereals fell by 2 times, many farmers went bankrupt (Ross 1997, p.68; Bernstein 1987, p. 46).
The actions of the government led not only to the limitation of free international trade, but also to the significant decrease in the inside free entrepreneurship activity: there were no more favorable conditions for starting small and medium business; the taxes for large business were also raised, the investors lost initiative and stimuli, while the monopoly of the state authorities’ decision-making in the economic sector was only expanding (Higgs 1997, p. 568; Reed 2010, p.4).
But, undoubtedly, the greatest burden of the economic crisis objectively rested on the shoulders of ordinary citizens. The massive decline in industrial production, the closure of tens of thousands of factories, mines and huge underemployment of production facilities – all this led to a tremendous increase in unemployment. The army of the unemployed, highly significant in the period of capitalist stabilization of the 1920’s, now increased many times over (Solomou & Weale 2010, p. R58). If we add the fact that the U.S. had no state social insurance system, and many banks collapsed taking away the deposits of citizens, we can say that people had no hopes either for aid from the state or to get their money back. Many people faced a real threat of starvation. People lost the faith in themselves, their power and for a long time were in a state of psychological depression, which was much worse than the economic one (McElvaine 1993, p. 173).
However, the situation of people who kept their job was not much better. The constant oppressive feeling of insecurity and fear of losing their jobs was supplemented with the constantly lowering wages. Thus, the process of impoverishment was just gaining its momentum (Cole & Ohanian 1999, p.11).
In addition, despite the fact that carrying out economic reforms newdealers were guided primarily by pragmatic considerations a certain objectively historical pattern loomed in their actions: they pushed and forced the state-monopolistic tendencies in the development of American capitalism. Thus, the reforms proved to be a tool to strengthen the state-monopolistic nature of American capitalism. In general, the inefficiency of the financial and economic measures of the New Deal brought the advent of the new economic collapse in 1937 (Bordo 1989, p. 46).
The depression immediately spread to the European economies, but Europe really felt the whole force of the impact in 1931. The collapse of the mighty Austrian bank “Creditanstalt” in May was the beginning of the fall of the economy of Central Europe. It was an especially hard time for Germany depending on the depleting American loans and investments. Unemployment in the country reached 6 million people (Gates 1974, p. 336). Within weeks, the crisis followed in Britain; it also impacted less industrialized nations such as France and Italy. With the sharp decline in demand for many products – such as coffee, sugar, cotton and silk – most of exporters got impoverished, from Brazil to Japan (Gates 1974, p. 334).
The depression led to great political changes in the early 1930’s. In Britain the Labour government fell, and the party itself was split. Labourist leaders entered into the coalition with the Conservatives and the Liberals and formed the coalition government which cut unemployment benefits and salaries to civil servants. These harsh measures led to mutiny in the navy in the Inver-Gordon (Scotland) and the “hunger marches” of the unemployed to London (Gates 1974, p. 334).
Government failed to save the pound and Britain had to refuse from the gold standard – financial stability. The principle of free trade was also sacrificed: to protect domestic producers, Britain imposed duties on many imported goods. This policy, known as protectionism, was applied by many countries, which led to reduction in global trade and slowed the overall economic recovery (Gates 1974, p. 336).
In Germany, the depression caused such a frustration and anger that Adolf Hitler and his Nazi party came to power. It could have been a coincidence, but Hitler chose an economic course, unsuccessfully advocated by the British economist John Maynard Keynes, who argued that the government should not save but spend, start big public works projects to create jobs and give a new impetus to the economy (Bordo 1989, p. 26). The Nazis were spending money on arms and construction of roads, because of it was required by the aggressive plans of Hitler, but the result was exactly what Keynes predicted: unemployment disappeared, and Hitler became a miracle worker in the eyes of millions of people (Gates 1974, p. 335). Militarism played a similar role in Japan.
As a result, we can say that the Great Depression, which began in the U.S., led to the World War II. Indeed, the reduction in world trade caused by tariff wars became one of the prerequisites of the Second World War, which began a few years later. In 1929, other countries owed 30 billion dollars to U.S. citizens (Bordo 1989, p. 48). The Weimar Republic was hardly paying huge reparations imposed on it by the Treaty of Versailles. When due to fees the foreign businessmen almost lost the opportunity to sell their goods in the U.S. market, the burden of their debts became much heavier, and it inspired such demagogues as Adolf Hitler (Gates 1974, p. 356).
Conclusion
The roots of the Great Depression could be found in the irresponsible fiscal and monetary policy of the U.S. authorities in late 1920’s – early 1930’s. This policy involved a row of serious failures: poor management performed by the central bank, tariffs destructive for the international trade, taxes deteriorating private initiative, torporific governmental control over production and competition, senseless destruction of harvests and cattle, as well as involuntary labor laws, which actually are far not the last to complete the list. Thus, not free market and large-scale political incompetence finally led to the 12 years of agony, not only in the USA, but in many countries of the world.
In Britain the Great Depression contributed to the reorganization of the economy and an influx of investment in old industries; for France it brought the loss of positions in world markets; in Germany the depression resulted in the National Socialists coming to power headed by Hitler; in Italy it initiated the establishment of fascism; other European countries also significantly suffered from this global crisis.
The general result of a long-lasting economic crisis was previously inexperienced sharpening of the political situation in the capitalist countries, both within and between them. The intensification of struggle for foreign markets, destruction of the last remains of free trade, prohibitive custom duties, trade war, the war of currencies, dumping and many other activities similar to them that demonstrated the extreme nationalism in economic policies, exacerbated to the extreme extent the relations between the countries and created a fertile soil for military collisions and placed on a waiting list the war as the means for the new redivision of the world and spheres of influence in favor of more powerful states.
In general, the recovery of the U.S. economy took about 20 years; the United States finally managed to rise to their feet and get out of depression only in the 1950’s. This was mainly due to Lend-Lease Act adopted on March 11, 1941, under which the U.S. were later able to supply huge supplies of weapons and war materials to Great Britain, Russia, China, Brazil and many other countries, as well as due to the World War II itself, which gave work to everybody by means of the war industry development. Thus, the Great Depression not only led to the war, but was also cured by this war, as paradoxical as it was from a historical and economic point of view.
