Wednesday, January 29, 2014

The Great Depression


THE GREAT DEPRESSION was a severe worldwide in the decade preceding . The timing of the Great Depression varied across nations, but in most countries it started in 1930 and lasted until the late 1930s or middle 1940s. It was the longest, most widespread, and deepest depression of the 20th century.

In the 21st century, the Great Depression is commonly used as an example of how far the world's economy can decline. The depression originated in the U.S., after the fall in stock prices that began around September 4, 1929, and became worldwide news with the of October 29, 1929 (known as ).

The Great Depression had devastating effects in countries and . , tax revenue, profits and prices dropped, while international trade plunged by more than 50%. Unemployment in the U.S. rose to 25%, and in some countries rose as high as 33%.

were hit hard, especially those dependent on . Construction was virtually halted in many countries. and rural areas suffered as crop prices fell by approximately 60%. Facing plummeting demand with few alternate sources of jobs, areas dependent on such as , and suffered the most.

Some economies started to recover by the mid-1930s. In many countries, the negative effects of the Great Depression lasted until after the end of World War II.

Economic historians usually attribute the start of the Great Depression to the sudden devastating collapse of US stock market prices on October 29, 1929, known as ; some dispute this conclusion, and see the stock crash as a symptom, rather than a cause, of the Great Depression.

Even after the Wall Street Crash of 1929, optimism persisted for some time; said that "These are days when many are discouraged. In the 93 years of my life, depressions have come and gone. Prosperity has always returned and will again." The stock market turned upward in early 1930, returning to early 1929 levels by April. This was still almost 30% below the peak of September 1929.

Together, government and business spent more in the first half of 1930 than in the corresponding period of the previous year. On the other hand, consumers, many of whom had suffered severe losses in the stock market the previous year, cut back their expenditures by ten percent. Likewise, beginning in mid-1930, a severe drought ravaged the agricultural heartland of the US.

By mid-1930, interest rates had dropped to low levels, but expected and the continuing reluctance of people to borrow meant that consumer spending and investment were depressed. By May 1930, automobile sales had declined to below the levels of 1928. Prices in general began to decline, although wages held steady in 1930; but then a started in 1931. Conditions were worse in farming areas, where commodity prices plunged, and in mining and logging areas, where unemployment was high and there were few other jobs.

The decline in the was the factor that pulled down most other countries at first, then internal weaknesses or strengths in each country made conditions worse or better. Frantic attempts to shore up the economies of individual nations through policies, such as the 1930 U.S. and retaliatory tariffs in other countries, exacerbated the collapse in global trade. By late 1930, a steady decline in the world economy had set in, which did not reach bottom until 1933.







Industrial production





Wholesale prices





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CAUSES Main article:

Crowd gathering at the intersection of and Broad Street after the

There were multiple causes for the first downturn in 1929. These include the structural weaknesses and specific events that turned it into a major depression and the manner in which the downturn spread from country to country. In relation to the 1929 downturn, historians emphasize structural factors like major bank failures and the stock market crash. In contrast, monetarist economists (such as , and ) point to monetary factors such as actions by the US that contracted the money supply, as well as Britain's decision to return to the at pre-World War I parities (US$4.86:EUR1).

Recessions and are thought to be a normal part of living in a world of inexact balances between . What turns a normal recession or 'ordinary' business cycle into a depression is a subject of much debate and concern. Scholars have not agreed on the exact causes and their relative importance. The search for causes is closely connected to the issue of avoiding future depressions. A related question is whether the Great Depression was primarily a failure on the part of or a failure of government efforts to regulate , curtail widespread bank failures, and control the money supply.

Current theories may be broadly classified into two main points of view and several heterodox points of view. There are demand-driven theories, most importantly , but also including those who point to the breakdown of international trade, and who point to and over-investment (causing an ), by bankers and industrialists, or incompetence by government officials. The consensus among demand-driven theories is that a large-scale loss of confidence led to a sudden reduction in consumption and investment spending. Once panic and deflation set in, many people believed they could avoid further losses by keeping clear of the markets. Holding money became profitable as prices dropped lower and a given amount of money bought ever more goods, exacerbating the drop in demand.

There are the , who believe that the Great Depression started as an ordinary recession, but that significant policy mistakes by monetary authorities (especially the ), caused a shrinking of the money supply which greatly exacerbated the economic situation, causing a recession to descend into the Great Depression. Related to this explanation are those who point to causing those who borrow to owe ever more in real terms.

There are also various that downplay or reject the explanations of the Keynesians and monetarists. For example, some have argued that various labor market policies imposed at the start caused the length and severity of the Great Depression. The focuses on the effects of , and how decisions can lead to over-investment ().


Keynes' basic idea was simple: to keep people fully employed, governments have to run deficits when the economy is slowing, as the private sector would not invest enough to keep production at the normal level and bring the economy out of recession. Keynesian economists called on governments during times of to pick up the slack by increasing and/or cutting taxes.

As the Depression wore on, tried , , and other devices to restart the US economy, but never completely gave up trying to balance the budget. According to the Keynesians, this improved the economy, but Roosevelt never spent enough to bring the economy out of recession until the start of World War II.


Crowd at New York's American Union Bank during a early in the Great Depression.

, including , argue that the Great Depression was mainly caused by , the consequence of poor policy-making by the American Federal Reserve System and continued crisis in the banking system. In this view, the Federal Reserve, by not acting, allowed the money supply as measured by the to shrink by one-third from 1929-1933, thereby transforming a normal recession into the Great Depression. Friedman argued that the downward turn in the economy, starting with the stock market crash, would have been just another recession.

The Federal Reserve allowed some large public bank failures - particularly that of the - which produced panic and widespread runs on local banks, and the Federal Reserve sat idly by while banks collapsed. He claimed that, if the Fed had provided emergency lending to these key banks, or simply bought on the to provide liquidity and increase the quantity of money after the key banks fell, all the rest of the banks would not have fallen after the large ones did, and the money supply would not have fallen as far and as fast as it did.

With significantly less money to go around, businessmen could not get new loans and could not even get their old loans renewed, forcing many to stop investing. This interpretation blames the Federal Reserve for inaction, especially the New York branch.

One reason why the Federal Reserve did not act to limit the decline of the money supply was regulation. At that time, the amount of credit the Federal Reserve could issue was limited by the , which required 40% gold backing of Federal Reserve Notes issued. By the late 1920s, the Federal Reserve had almost hit the limit of allowable credit that could be backed by the gold in its possession. This credit was in the form of Federal Reserve demand notes.

A "promise of gold" is not as good as "gold in the hand", particularly when they only had enough gold to cover 40% of the Federal Reserve Notes outstanding. During the bank panics a portion of those demand notes were redeemed for Federal Reserve gold. Since the Federal Reserve had hit its limit on allowable credit, any reduction in gold in its vaults had to be accompanied by a greater reduction in credit. On April 5, 1933, President Roosevelt signed making the private ownership of , coins and bullion illegal, reducing the pressure on Federal Reserve gold.


From the point of view of today's mainstream schools of economic thought, government should strive to keep the interconnected macroeconomic aggregates and/or on a stable growth path. When threatened by the forecast of a depression should pour liquidity into the banking system and the government should cut taxes and accelerate spending in order to keep the nominal money stock and total nominal demand from collapsing. In contrast in the 1920s leave-it-alone liquidationism was a common position for economists to take. Those liquidationists thought that a depression is good medicine. In their opinion the function of a depression was to liquidate failed investments and businesses that have been made obsolete by technological development in order to release factors of production (capital and labor) from unproductive uses so that these could be redeployed in other sectors of the technologically dynamic economy. They argued that even if self-adjustment of the economy took mass bankruptcies, then so be it. An increasingly common view among economic historians is that the adherence of some Federal Reserve policymakers to the liquidationist thesis led to disastrous consequences. Regarding the policies of President Hoover, economists like and point out that President Hoover tried to keep the federal budget balanced until 1932, when he lost confidence in his Secretary of the Treasury and replaced him. Despite liquidationist expectations, a large proportion of the capital stock was not redeployed but vanished during the first years of the Great Depression. According to a study by and , the recession caused a drop of net to pre-1924 levels by 1933. Milton Friedman called the leave-it-alone liquidationism "dangerous nonsense" He wrote:

I think the Austrian business-cycle theory has done the world a great deal of harm. If you go back to the 1930s, which is a key point, here you had the Austrians sitting in London, Hayek and Lionel Robbins, and saying you just have to let the bottom drop out of the world. You've just got to let it cure itself. You can't do anything about it. You will only make it worse.I think by encouraging that kind of do-nothing policy both in Britain and in the United States, they did harm.



Another explanation comes from the of economics. Theorists of the "Austrian School" who wrote about the Depression include Austrian economist and American economist , who wrote (1963). In their view and like the monetarists, the Federal Reserve, which was created in 1913, shoulders much of the blame; but in opposition to the monetarists, they argue that the key cause of the Depression was the expansion of the in the 1920s that led to an unsustainable credit-driven boom.

In the Austrian view it was this inflation of the money supply that led to an unsustainable boom in both asset prices (stocks and bonds) and . By the time the Fed belatedly tightened in 1928, it was far too late and, in the Austrian view, a significant economic contraction was inevitable. In February 1929 Hayek published a paper predicting the Federal Reserve's actions would lead to a crisis starting in the stock and credit markets. According to the Austrians, the artificial interference in the economy was a disaster prior to the Depression, and government efforts to prop up the economy after the crash of 1929 only made things worse.

According to Rothbard, government intervention delayed the market's adjustment and made the road to complete recovery more difficult. However, Hayek, unlike Rothbard, also believed, along with the monetarists, that the Federal Reserve further contributed to the problems of the Depression by permitting the money supply to shrink during the earliest years of the Depression.


saw recession and depression as unavoidable under free-market capitalism as there are no restrictions on accumulations of capital other than the market itself. In the view, tends to create unbalanced accumulations of wealth, leading to over-accumulations of capital which inevitably lead to a . This especially sharp bust is a regular feature of the pattern of what Marxists term "chaotic" capitalist development. It is a tenet of many Marxist groupings that such crises are inevitable and will be increasingly severe until the contradictions inherent in the mismatch between the mode of production and the reach the final point of failure. At which point, the crisis period encourages intensified class conflict and forces societal change.



argued that the predominant factor leading to the Great Depression was over-indebtedness and deflation. Fisher tied loose credit to over-indebtedness, which fueled speculation and asset bubbles. He then outlined 9 factors interacting with one another under conditions of debt and deflation to create the mechanics of boom to bust. The chain of events proceeded as follows:

* Debt liquidation and distress selling

* Contraction of the money supply as bank loans are paid off

* A fall in the level of asset prices

* A still greater fall in the net worth of business, precipitating bankruptcies

* A fall in profits

* A reduction in output, in trade and in employment.

*and loss of confidence

* Hoarding of money

* A fall in nominal interest rates and a rise in deflation adjusted interest rates.

Crowds outside the in New York after its failure in 1931

During the Crash of 1929 preceding the Great Depression, margin requirements were only 10%. Brokerage firms, in other words, would lend $9 for every $1 an investor had deposited. When the market fell, brokers , which could not be paid back.

Banks began to fail as debtors defaulted on debt and depositors attempted to withdraw their deposits en masse, triggering multiple . Government guarantees and Federal Reserve banking regulations to prevent such panics were ineffective or not used. Bank failures led to the loss of billions of dollars in assets.

Outstanding debts became heavier, because prices and incomes fell by 20-50% but the debts remained at the same dollar amount. After the panic of 1929, and during the first 10 months of 1930, 744 US banks failed. (In all, 9,000 banks failed during the 1930s). By April 1933, around $7 billion in deposits had been frozen in failed banks or those left unlicensed after the .

Bank failures snowballed as desperate bankers called in loans which the borrowers did not have time or money to repay. With future profits looking poor, and construction slowed or completely ceased. In the face of bad loans and worsening future prospects, the surviving banks became even more conservative in their lending. Banks built up their capital reserves and made fewer loans, which intensified deflationary pressures. A developed and the downward spiral accelerated.

The liquidation of debt could not keep up with the fall of prices which it caused. The mass effect of the stampede to liquidate increased the value of each dollar owed, relative to the value of declining asset holdings. The very effort of individuals to lessen their burden of debt effectively increased it. Paradoxically, the more the debtors paid, the more they owed. This self-aggravating process turned a 1930 recession into a 1933 great depression.

including , the current chairman of the , have revived the debt-deflation view of the Great Depression originated by Fisher.


Recent work from a neoclassical perspective focuses on the decline in productivity that caused the initial decline in output and a prolonged recovery due to policies that affected the labor market. This work, collected by and Prescott, decomposes the economic decline into a decline in the , capital stock, and the productivity with which these inputs are used.

This study suggests that theories of the Great Depression have to explain an initial severe decline but rapid recovery in productivity, relatively little change in the capital stock, and a prolonged depression in the labor force. This analysis rejects theories that focus on the role of savings and posit a decline in the capital stock.


Many economists have argued that the sharp decline in international trade after 1930 helped to worsen the depression, especially for countries significantly dependent on foreign trade. Most historians and economists partly blame the American (enacted June 17, 1930) for worsening the depression by seriously reducing international trade and causing retaliatory tariffs in other countries. While foreign trade was a small part of overall economic activity in the U.S. and was concentrated in a few businesses like farming, it was a much larger factor in many other countries. The average rate of duties on dutiable imports for 1921-1925 was 25.9% but under the new tariff it jumped to 50% in 1931-1935.

In dollar terms, American exports declined from about $5.2 billion in 1929 to $1.7 billion in 1933; but prices also fell, so the physical volume of exports only fell by half. Hardest hit were farm commodities such as wheat, cotton, tobacco, and lumber. According to this theory, the collapse of farm exports caused many American farmers to default on their loans, leading to the on small rural banks that characterized the early years of the Great Depression.


displaces tenants from the land in the western dry cotton area. , 1938

Two economists of the 1920s, and , popularized a theory that influenced many policy makers, including Herbert Hoover, , , and . It held the economy produced more than it consumed, because the consumers did not have enough income. Thus the unequal throughout the 1920s caused the Great Depression.

According to this view, the of the Great Depression was a global over-investment in heavy industry capacity compared to wages and earnings from independent businesses, such as farms. The solution was the government must pump money into consumers' pockets. That is, it must redistribute purchasing power, maintain the industrial base, but re-inflate prices and wages to force as much of the inflationary increase in purchasing power into . The economy was overbuilt, and new factories were not needed. Foster and Catchings recommended federal and state governments start large construction projects, a program followed by Hoover and Roosevelt.

Productivity Shock

It cannot be emphasized too strongly that the [productivity, output and employment] trends we are describing are long-time trends and were thoroughly evident prior to 1929. These trends are in nowise the result of the present depression, nor are they the result of the World War. On the contrary, the present depression is a collapse resulting from these long-term trends. --

The first three decades of the 20th century saw economic output surge with , and motorized farm machinery, and because of the rapid growth in productivity there was a lot of excess production capacity and the work week was being reduced.

The dramatic rise in of major industries in the U. S. and the effects of productivity on output, wages and the work week are discussed by Spurgeon Bell in his book Productivity, Wages, and National Income (1940).


The overall course of the Depression in the United States, as reflected in per-capita GDP (average income per person) shown in constant year 2000 dollars, plus some of the key events of the period

In most countries of the world, recovery from the Great Depression began in 1933. In the U.S., recovery began in early 1933, but the U.S. did not return to 1929 GNP for over a decade and still had an unemployment rate of about 15% in 1940, albeit down from the high of 25% in 1933. The in this time period was unsophisticated and complicated by the presence of massive , in which engaged in rationing of jobs.[]

There is no consensus among economists regarding the motive force for the U.S. economic expansion that continued through most of the Roosevelt years (and the 1937 recession that interrupted it). The common view among most economists is that Roosevelt's policies either caused or accelerated the recovery, although his policies were never aggressive enough to bring the economy completely out of recession. Some economists have also called attention to the positive effects from expectations of and rising nominal interest rates that Roosevelt's words and actions portended. It was the rollback of those same reflationary policies that led to the interrupting recession of 1937. One contributing policy that reversed reflation was the Banking Act of 1935, which effectively raised reserve requirements, causing a monetary contraction that helped to thwart the recovery. GDP returned to its upward trend in 1938.

According to , the money supply growth caused by huge international gold inflows was a crucial source of the recovery of the United States economy, and that the economy showed little sign of self-correction. The gold inflows were partly due to and partly due to deterioration of the political situation in Europe. In their book, , Milton Friedman and also attributed the recovery to monetary factors, and contended that it was much slowed by poor management of money by the . Current Ben Bernanke agrees that monetary factors played important roles both in the worldwide economic decline and eventual recovery. Bernanke, also sees a strong role for institutional factors, particularly the rebuilding and restructuring of the financial system, and points out that the Depression needs to be examined in international perspective.


The Depression in international perspective

Some economic studies have indicated that just as the downturn was spread worldwide by the rigidities of the , it was suspending gold convertibility (or devaluing the currency in gold terms) that did the most to make recovery possible.

Every major currency left the gold standard during the Great Depression. Great Britain was the first to do so. Facing on the and depleting , in September 1931 the ceased exchanging pound notes for gold and the pound was floated on foreign exchange markets.

Great Britain, Japan, and the Scandinavian countries left the gold standard in 1931. Other countries, such as Italy and the U.S., remained on the gold standard into 1932 or 1933, while a few countries in the so-called "gold bloc", led by France and including Poland, Belgium and Switzerland, stayed on the standard until 1935-1936.

According to later analysis, the earliness with which a country left the gold standard reliably predicted its economic recovery. For example, Great Britain and Scandinavia, which left the gold standard in 1931, recovered much earlier than France and Belgium, which remained on gold much longer. Countries such as China, which had a , almost avoided the depression entirely. The connection between leaving the gold standard as a strong predictor of that country's severity of its depression and the length of time of its recovery has been shown to be consistent for dozens of countries, including . This partly explains why the experience and length of the depression differed between national economies.


A female factory worker in 1942, . Women entered the workforce as men were into the armed forces

The common view among economic historians is that the Great Depression ended with the advent of World War II. Many economists believe that government spending on the war caused or at least accelerated recovery from the Great Depression, though some consider that it did not play a very large role in the recovery. It did help in reducing unemployment.

The rearmament policies leading up to World War II helped stimulate the economies of Europe in 1937-39. By 1937, unemployment in Britain had fallen to 1.5 million. The of manpower following the outbreak of war in 1939 ended unemployment.

The US' entry into the war in 1941 finally eliminated the last effects from the Great Depression and brought the U.S. unemployment rate down below 10%. In the U.S., massive war spending doubled economic growth rates, either masking the effects of the Depression or essentially ending the Depression. Businessmen ignored the mounting and heavy new taxes, redoubling their efforts for greater output to take advantage of generous government contracts.


An impoverished American family living in a shanty, 1936

The majority of countries set up relief programs, and most underwent some sort of political upheaval, pushing them to the left or right. In some states, the desperate citizens turned toward nationalist -- infamously propelling to power in Germany -- setting the stage for World War II.

AUSTRALIA Main article:

Australia's dependence on agricultural and industrial meant it was one of the hardest-hit countries in the . Falling export demand and commodity prices placed massive downward pressures on wages. Further, reached a record high of 29% in 1932, with incidents of becoming common. After 1932, an increase in wool and meat prices led to a gradual recovery.

CANADA Main article:

Unemployed men march in , , Canada

Harshly affected by both the global economic downturn and the , Canadian industrial production had fallen to only 58% of the 1929 level by 1932, the second lowest level in the world after the United States, and well behind nations such as Britain, which saw it fall only to 83% of the 1929 level. Total fell to 56% of the 1929 level, again worse than any nation apart from the United States. Unemployment reached 27% at the depth of the Depression in 1933.

CHILE Further information:

The labeled the country hardest hit by the Great Depression because 80% of government revenue came from exports of copper and nitrates, which were in low demand. Chile initially felt the impact of the Great Depression in 1930, when GDP dropped 14%, mining income declined 27%, and export earnings fell 28%. By 1932, GDP had shrunk to less than half of what it had been in 1929, exacting a terrible toll in unemployment and business failures.

Influenced profoundly by the Great Depression, many national leaders promoted the development of local industry in an effort to insulate the economy from future external shocks. After six years of government , which succeeded in reestablishing Chile's creditworthiness, Chileans elected to office during the 1938-58 period a succession of center and left-of-center governments interested in promoting economic growth by means of government intervention.

Prompted in part by the devastating , the government of created the Production Development Corporation (Corporaci n de Fomento de la Producci n, ) to encourage with subsidies and direct investments an ambitious program of . Consequently, as in other Latin American countries, became an entrenched aspect of the Chilean economy.

CHINA Main article:

China was largely unaffected by the Depression, mainly by having stuck to the . However, the US silver purchase act of 1934 created an intolerable demand on China's silver coins, and so in the end the silver standard was officially abandoned in 1935 in favor of the four Chinese national banks' "legal note" issues. China and the British colony of Hong Kong, which followed suit in this regard in September 1935, would be the last to abandon the silver standard. In addition, the also acted energetically to modernize the legal and penal systems, stabilize prices, amortize debts, reform the banking and currency systems, build railroads and highways, improve public health facilities, legislate against traffic in narcotics and augment industrial and agricultural production. On November 3, 1935, the government instituted the fiat currency (fapi) reform, immediately stabilizing prices and also raising revenues for the government.

FRANCE Main article:

The Depression began to affect France around 1931. France's relatively high degree of self-sufficiency meant the damage was considerably less than in nations like Germany. Hardship and unemployment were high enough to lead to and the rise of the . Ultra-nationalist groups also saw increased popularity, although democracy prevailed into .

GERMANY Main article:

speaking in 1935

Germany's was hit hard by the depression, as American loans to help rebuild the German economy now stopped. Unemployment soared, especially in larger cities, and the veered toward . The unemployment rate reached nearly 30% in 1932, bolstering support for the Nazi (NSDAP) and Communist (KPD) parties, which both rose in the years following the crash to altogether possess a Reichstag majority following the .

Repayments of the war reparations due by Germany were suspended in 1932 following the . By that time, Germany had repaid one eighth of the reparations. and the came to power in January 1933, establishing within months and initiating the path towards , the .


The Great Depression did not strongly affect Japan. The Japanese economy shrank by 8% during 1929-31. Japan's Finance Minister was the first to implement what have come to be
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