57. Great Depression - How It could have been Prevented

Updated: Jun 5, 2020

I. What is Great Depression ?


The Great Depression was a severe worldwide economic depression that took place mostly during the 1930s, beginning in the United States. The timing of the Great Depression varied across the world; in most countries, it started in 1929 and lasted until the late 1930s. It was the longest, deepest, and most widespread depression of the 20th century.The Great Depression is commonly used as an example of how intensely the global economy can decline.


Pic : Dorothea Lange's Migrant Motherdepicts destitute pea pickers in California, centering on Florence Owens Thompson, age 32, a mother of seven children, in Nipomo, California, March 1936.


The Great Depression started in theUnited States after a major fall in stock prices that began around September 4, 1929, and became worldwide news with the stock market crash of October 29, 1929, (known as Black Tuesday). Between 1929 and 1932, worldwide gross domestic product (GDP) fell by an estimated 15%. By comparison, worldwide GDP fell by less than 1% from 2008 to 2009 during the Great Recession. Some economies started to recover by the mid-1930s. However, in many countries, the negative effects of the Great Depression lasted until the beginning of World War II.


The Great Depression had devastating effects in both rich and poor countries. Personal income, tax revenue, profits and prices dropped,

while international trade fell by more than 50%.

Unemployment in the U.S. rose to 23% and in some countries rose as high as 33%.

Cities around the world were hit hard, especially those dependent on heavy industry. Construction was virtually halted in many countries. Farming communities and rural areas suffered as crop prices fell by about 60%. Facing plummeting demand with few alternative sources of jobs, areas dependent on primary sector industries such as mining and logging suffered the most.


II. What happened during Great Depression

  1. Debt liquidation and distress selling

  2. Contraction of the money supply as bank loans are paid off

  3. A fall in the level of asset prices

  4. A still greater fall in the net worth of businesses, precipitating bankruptcies

  5. A fall in profits

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

  7. Pessimism and loss of confidence

  8. Hoarding of money

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

III. Possible Reasons for Great Depression


The 1929 stock market crash often comes to mind first when people think about the Great Depression. The crash destroyed considerable wealth. Perhaps even more important, the crash sparked doubts about the health of the economy

, which led consumers and firms to pull back on their spending, especially on big-ticket items like cars and appliances. However, as big as it was, the stock market crash alone did not cause the Great Depression.


Other experts offer different explanations for the Great Depression. Some historians have called the Depression an inevitable failure of capitalism. Others blame the Depression on the “excesses” of the 1920s: excessive production of commodities, excessive building, excessive financial speculation or an excessively skewed Introduction xii distribution of income and wealth. None of these explanations has held up very well over time.


One explanation that has stood the test of time focuses on the collapse of the U.S. banking system and resulting contraction of the nation’s money stock. Economists Milton Friedman and Anna Schwartz make a strong case that a falling money stock caused the sharp decline in output and prices in the economy. As the money stock fell, spending on goods and services declined, which in turn caused firms to cut prices and output and to lay off workers. The resulting decline in incomes made it harder for borrowers to repay loans. Defaults and bankruptcies soared, creating a vicious spiral in which more banks failed, the money stock contracted further, and output, prices and employment continued to decline.


Economic historians usually consider the catalyst of the Great Depression to be the sudden devastating collapse of U.S. stock market prices, starting on October 24, 1929. However, some dispute this conclusion and see the stock crash as a symptom, rather than a cause, of the Great Depression.


Pic : Crowd at New York's American Union Bank during abank runearly in the Great Depression


Even after the Wall Street Crash of 1929 optimism persisted for some time. John D. Rockefeller said "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 10%. In addition, beginning in the mid-1930s, a severe drought ravaged the agricultural heartland of the U.S.



By mid-1930, interest rates had dropped to low levels, but expected deflation 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. Then a deflationary spiral started in 1931. Farmers faced a worse outlook; declining crop prices and a Great Plains drought crippled their economic outlook. At its peak, the Great Depression saw nearly 10% of all Great Plains farms change hands despite federal assistance.



Pic : Crowd gathering at the intersection ofWall Streetand Broad Street after the1929 crash


The decline in the U.S. economy 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 states across the world through protectionist policies, such as the 1930 U.S. Smoot–Hawley Tariff Act and retaliatory tariffs in other states, exacerbated the collapse in global trade. By 1933, the economic decline had pushed world trade to one third of its level just four years earlier.


V. Mainstream explanations


Modern mainstream economists see the reasons in

  • Insufficient demand from the private sector and insufficient fiscal spending (Keynesians).

  • A money supply reduction ( Monetarists) and therefore a banking crisis, reduction of credit and bankruptcies.

Insufficient spending, the money supply reduction and debt on margin led to falling prices and further bankruptcies (Irving Fisher's debt deflation).


V. Keynesian View


British economist John Maynard Keynes argued in The General Theory of Employment, Interest and Money that lower aggregate expenditures in the economy contributed to a massive decline in income and to employment that was well below the average. In such a situation, the economy reached equilibrium at low levels of economic activity and high unemployment.


Keynes's 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 economic crisis to pick up the slack by increasing government spending or cutting taxes.


As the Depression wore on, Franklin D. Roosevelt tried public works, farm subsidies, and other devices to restart the U.S. 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.

Pic : Crowds outside the Bank of United States in New York after its failure in 1931


VI. Monetarist View

The monetarist explanation was given by American economists Milton Friedman and Anna J. Schwartz.They argued that the Great Depression was caused by the banking crisis that caused one-third of all banks to vanish, a reduction of bank shareholder wealth and more importantly monetary contraction of 35%, which they called "The Great Contraction". This caused a price drop of 33% (deflation).[25] By not lowering interest rates, by not increasing the monetary base and by not injecting liquidity into the banking system to prevent it from crumbling, the Federal Reserve passively watched the transformation of a normal recession into the Great Depression.


Friedman and Schwartz argued that the downward turn in the economy, starting with the stock market crash, would merely have been an ordinary recession if the Federal Reserve had taken aggressive action.This view was endorsed by Federal Reserve Governor Ben Bernanke in a speech honoring Friedman and Schwartz with this statement:

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression, you're right. We did it. We're very sorry. But thanks to you, we won't do it again. — Ben S. Bernanke

The Federal Reserve allowed some large public bank failures – particularly that of the New York Bank of United States – which produced panic and widespread runs on local banks, and the Federal Reserve sat idly by while banks collapsed. Friedman and Schwartz argued that, if the Fed had provided emergency lending to these key banks, or simply bought government bonds on the open market 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, businesses 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 the gold standard. At that time, the amount of credit the Federal Reserve could issue was limited by the Federal Reserve Act, 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.

VII. How It could have been prevented ?


The Great depression could have been avoided, firstly over production. Factories and farms were producing more goods than the people could afford to buy. The problem with over production was that no one was looking forward for what was to come. They were on such a high with the amount of products they were selling ( washing machines, dish washers, cars, wheat, meat and other farm goods) no one noticed that they were making extensive amounts.


Is was getting easier and easier to produce products because assembly line production, and stock market prices were high. World War I had just ended, people were happy, businesses were doing fantastic, the stock market was at an all time high, there was no reasons  to start worrying about what was to come.  As a result, prices fell, factories closed and workers were laid off.  Prices for farm products also fell, as a result, farmers could not pay off bank loans and many lost their farms due to foreclosure.


Secondly, buying on credit…1920’s motto was “ buy now, pay later ”, first mistake because most people couldn’t afford to pay later. Buying on credit was a new concept, and not everyone understood it. Almost all people didn’t own the majority of things they had, resulting in Canada falling helplessly into debt. Then creditors repossessed goods and left some with nothing. Buying on credit should have only been available to people who have a well paying job and know how a fact that they will be able to pay the money back.


Thirdly, the stock market crash, also known as “Black Tuesday”. Too many people were getting loans to buy shares (buying on margin), so when the stock market prices went down, people couldn’t pay back their loans… This caused people to sell shares. The government needed to stop the bubble in stock prices from happening.  They could have outlawed (or at least regulated) the margin buying and some of the other abuses that were pushing up stock prices.


Conclusion


In conclusion,the Great Depression negatively affected the United States involvement in their economy.The Great Depression broke the confidence of the American people as well as their leaders.The future of their economy was unclear and shaky strategies were used in order to attempt to recover.


Necessary steps should be taken against any over production, particularly in the times of Demand Contraction.


Creadit Quality should be well structured with procedures and firm Checks and Balances and lending Institutions should work under the Guidelines of Central Banks. Buying on credit should have only been available to people who have a well paying job or capability to repay, otherwise, Banks will end up with too much of Non-Performing Assets ( NPAs) and its one of the early warning systems on the health of the Economy and suitable State's intervention is very much desirable under this circumstances.


Too many people were getting loans to buy shares (buying on margin), so when the stock market prices went down, people couldn’t pay back their loans and these kind of incidences are some of the reasons for collapse of Banks, thus Economy too.


Central Banks must be the custodians of State's Economy and they should install necessary Safeguards in the system to prevent any economic collapse and Central Banks should be run by Economic Experts and Technocrats.



MM Rao

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Sources :

https://www.stlouisfed.org/~/media/files/pdfs/great-depression/the-great-depression-wheelock-overview.pdf

http://www.blog44.ca/anatoliaf/2017/01/26/was-there-any-way-the-great-depression-could-have-been-avoided/

https://en.wikipedia.org/wiki/Great_Depression

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