This paper discusses and analyzes the causes and effects of the Great Depression which happened in the United States during 1929 to late 1930s or early 1940s. The causes of the Great Depression are several, for example, the drastic decline in the quantity of money in industrial economies and the drops of the price on agricultural products. Since the Great Depression is the longest, most widespread and worst depression in the 20th century, the effects are tremendous. Like economic nationalism formed because of the Great Depression, and even the burst of WWII is related to it. Finally, the paper would come up with recommendations on how to avoid this kind of depression in the future.
The Great Depression is a global economic depression which began on 1929, and it lasted until late 1930s or early 1940s. The Great Depression originated in the U.S., on September 4, 1929, the stock prices started decline around this period. On October 24, 1929, known as the “Black Thursday” in the American Financial history, a huge number of American investors sold their stocks on the markets because of panic and rumor, this caused stock prices to drop tremendously, which led the paper value of dollar drained. Then on October 29, 1929, known as the “Black Tuesday”, another wave of selling stocks occurred, which leads to further drop in the price of stocks, hence it quickly spread world widely to almost every county in the world. Like a folk rhyme said “Mellon pulled the whistle, Hoover rang the bell, Wall Street gave the signal and the country went to hell”, Mellon’s full name is Andrew William Mellon, he is an American bankers, industrialist, philanthropist, and most important, the Secretary of the Treasury during the beginning of the Great Depression. Hoover is 31st President of the United Stated also during the Great Depression.
And as said in the folk rhyme, the stock market crash is a symptom or signal, rather than a cause for the Great Depression. As Table 1 in the Appendix shows, the Industrial Average falls drastically during October, 1929. The Great Depression was the longest, most widespread, and deepest depression of the 20th century, and it is still used as an example of how bad the world’s economy can decline for nowadays. During just 2 weeks from October 29 to November 13, 1929, there was wealth worth than 30 billion dollars eliminated from the market, it equals to the overall spending in the WWI for the U.S. Moreover, in the early 1933, the unemployment rate reached its peak at 25% (Swanson, 1972), caused over 13.7 million workers lost their jobs. And nearly 10,000 banks had failed; hundreds of thousands of Americans became homeless, and began congregating in shanty towns-dubbed “Hoovervilles”-that began to appear across the country (Bryant 1964). According to Table 2 in Appendix, we can see how bad the United States suffered from the Great Depression by comparing to other countries also affected by the Great Depression. Like the unemployment in the U.S. is up to +607%,which means if the unemployment was 1 worker before and now is 6, while the Great Brain is +129%, France is +214% and Germany is +232%. So it is obviously important to examine why the Great Depression happened in the U.S. and the effects on economic structure and society, and come up with recommendations on how to avoid this kind of depression in the future. Causes
There were several causes of the Great Depression. First we begin with a survey of the 1920s as an examination for the overall production in the economy, GNP, the most comprehensive measure of aggregate economic activity. The real GNP growth in the 1920s was rapid; from 1920 to 1929 is 4.2 percent a year according to the most researches (Historical Statistics of the United States, or HSUS, 1976). Real GNP per capita grew 2.7 percent per year between 1920 and 1929. GNP represents Gross National Product; it is the measure of national income and national output. So it seems the U.S was in a good business shape, which originated from the stats above, the national income is increasing as well as national output. But the national income is not the real wage; real wage is equal to nominal wage, which is the national income divided by price level. And the national output level increase means that the net export of the country increases. As the Figure 1 showed below, we can see the increasing-trend line of GNP per capital. (Smiley 2010, under “National Product and income and prices”)
The WWI brought unexpected prosperity to American farmer, as the need for agricultural products in Europe, because of the interference of war, agricultural production in Europe declined, hence the demand for American agricultural exports increased, causing the rise of agricultural product production and incomes. So accordingly, American farmers expanded production by moving the production area to marginal farmland. Therefore, the consequence is resulted in the increasing of farmland price, especially marginal farmland, and debt of American farmers increased drastically. However, the recovery of Europe agricultural production was better than most people expected. Therefore, the demand for agricultural products decreased in Europe, thus causing the agricultural product price to drop. As the Figure 2 showed below (Smiley 2010, under “Agriculture”), from year 1921 to 1925, the real income per farm keeps increasing, after 1925, the major trend of real average income per farm started decreasing, especially after year 1929, drops drastically. Figure 2-Real average income per farm
Moreover in the year of 1928, the timber price in the U.S. falls, because of the competition of timber market against the Soviet Union and in 1929, American government had to lower the price of agricultural product since Canada overproduced wheat. Thus, the depression in agriculture and the dependency of developing countries on unstable international markets for their primary products’ exports is one cause for the Great Depression.
According to Milton Friedman’s quantity theory of money, the equation of exchange is m*v=P*Y, where m represents quantity of money, v is the velocity in circulation, p is the price level and Y is real GDP output. And in order to arrive at the quantity theory of money, first the velocity in circulation does not change as money supply changes. Second the output level does not change as the quantity of money changes in the long-run. So we can rewrite the equation as m*(v/Y) =P, (v/P) remains constant in the long-run, so if the money supply drops, the price level also follows to drop and the percentage decrease in the money supply equals to the percentage decrease in the price level, as if the money supply falls by 10%, then the price level will also fall by 10% (Fahmy 2011). So as the drastic decline in the quantity of money, that is also known as the decline in money supply in major industrial economies in the U.S., leads to the drop in the price level. As a result of this, deflation is expected.
And there are some economists argue one of the reasons that the American money supply declines is to back up money to preserve the gold standard. Gold standard means that the country’s currency is converted to a specified amount of gold on demand. After World War I, the United States was operating under the gold standard. If a country is under the gold standard, the government must honor its debt without resorting to inflationary financing that is printing money to finance its deficits when such paper money is not fully backed by gold (Fahmy 2011). And a country’s currency is also backed by tax revenue and foreign assets, since the currency is not fully backed by gold; the government needs to finance it by raising tax or selling foreign assets, which would influence the economy and standard of living.
Between 1926 and 1931, the world’s major economies insisted a gold standard with fixed exchange rates (Hamilton 1988). But before that, the world economy is seriously hurt by the WWI, which caused the misallocation of the world’s stock of gold, and the breakdown of the gold standard after WWI. Since the U.S. government is committed to the gold standard to prevent it from engaging in expansionary monetary policy, high interest rates had to be maintained as an attraction for international investors who can buy foreign assets with gold. However, high interest rate decreased domestic business borrowing. Consequently, the consumption and investment expenditure would fall.
Figure 3 shows, income per capita of the U.S. decreasing drastically after 1929, during that time, the government is in the fixed gold standard. As the triangle point shows in the figure, that is the point when the country left gold standard, accordingly the income per capita started to recover. Figure 3-income per capita
Bank failure is another cause of the Great Depression. The influences of bank failure are apparent as simply counting of the numbers of banks that fails. At the early stage of the Depression, banks that loaned to investors who were investing money in stock market were immediately at risk. As Figure 4 shows below. There were more than 25,000 banks in the U.S. in 1929, and in 1933, which was the lowest point; there were merely 15,000 banks left. And as the paper mentioned before, as the increasing loan made for farmers, and they cannot pay back the loan, hence dead loan is another element of the bank failure. Banks failed the public simply by Page 6
losing the savings. Even though there were banks still working, they concerned about the unstable economic environment, hence they would not be willing to lend money to public, consequently causing less expenditures. So the depression was getting worse. Figure 4- number of Banks in the U.S. (1000’s)
Also there are many other causes of the Great Depression, like the disruption of trade by following protective rather than free trade measures, for example, high tariffs policy. Economic nationalism acts as an economic policy in the 1920s and so on, due to the limitation of paper content; we are not discussing the details here.
As the Great Depression getting worse, the governments started to intervene to economy. In the year of 1930, President Herbert Hoover performed several programs to fight the Great Depression; one of them was the Smoot-Hawley Tariff Act, which increased tariffs on imported items. Consequently, this Act intended to encourage Americans to purchase domestic products by increasing the cost of imported goods, meanwhile raising revenue for the federal government and protecting consumers and farmers. But other countries also increased tariffs on American products, thus reducing international trade, then worsening the Great Depression. As the most obvious economic impact of the Great Depression was human suffering. During the Great Depression, productivity and standards of living dropped precipitously. The unemployment rate was incredible as 25% as the Figure 5 showed below. Figure 5- U.S. unemployment rate
The recovery of the Great Depression is always related with the New Deal. The New Deal is a series of economic programs implemented in the United States from 1933 to 1936 and they were passed by the U.S. Congress during the first term of President Franklin D. Roosevelt. Figure 6-U.S. real GDP .As the Figure 6 shows below, the real GDP started to recover around year of 1934 after a huge drop because of the Great Depression. In the “First New Deal” of 1933-4, programs, such as the National Recovery Administration (NRA), sought to stimulate demand and provide work and relief through increased government spending.
To end Deflation the Gold standard was suspended and a series of panels comprising business leaders in each industry set regulations which ended what was called “cut-throat competition,” believed to be responsible for forcing down prices and profits nationwide (Blanchard 2009). And during the Great Depression, tons of Americans could not find a job, the Works Progress Administration (WPA), acted as an ambitious New Deal program, put over 8,000,000 people back to work space. In short explanation, the New Deal is the relief of the unemployed and poor, the recovery of the economy and reform of the financial system to prevent a repeat depression. And in 1941, as the U.S. entered the WWII, the effects of Great Depression were finally eliminated and the unemployment rate was down below 10% as showed in Figure 5 above.
According to the researches in the paper, The Great Depression is the result as a complex combination of factors-tight monetary & fiscal policies, bank failure, collapse of the gold standard, decreasing of agricultural products’ price, the decline in domestic money supply and so on. And I’m convinced that the Great Depression could be avoided in the future if above factors get well-solved and with appropriate regulation on economy and market by the Federal Government, like gold reserve and standard regulation, currency flow and price control.
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Friedman, Milton and Heller, Walter W. 1969. Monetary vs. Fiscal Policy: A Dialogue, W.W. Norton & Company, Inc., pp. 79-80.
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