What Caused The Great Depression?

This article traces the collapse of the financial house of cards that led to the Great Depression, the darkest period in the history of the world economy.

Forbes predicted a recession to hit as early as 2023. It’s been quite a long time since we last faced a period as troubling as the Great Depression. But, can we remain hopeful that the lessons learned from the economic woes that impacted the whole world have enabled us to prevent such a massive catastrophic disaster in the future? Or must we revise our lessons by looking at what caused the Great Depression?

Origins of the Great Depression

The Great Depression was the darkest economic event in the history of the industrialized world. It lasted from 1929 to 1939. It started after the catastrophic stock market crash of October 1929, sending Wall Street into panic, and millions of investors vanished. Over the years, consumerism and investments dropped, causing steep declines in industrial output and employment as failing companies let workers go. By 1933, the Great Depression had hit rock bottom, some 15 million Americans were unemployed, and nearly half the country’s banks had failed.

How did the Great Depression start?

By the end of the 1920s, the U.S. boasted the largest economy in the world. Yet, with the destruction wrought by World War I, Europeans struggled while Americans flourished. Upon succeeding in the Presidency, Herbert Hoover predicted that the United States would soon see the day to eliminate poverty. But then, things fell apart drastically. The stock market crash of 1929 ticked off a chain of events that plunged the United States into the most extended, most profound economic crisis of its history.

America’s “Great Depression” began with the stock market crash on October 24, 1929, “Black Thursday,” when panicking investors sold 16 million shares of the stock in haste after losing faith in the American economy.

7 causes of the Great Depression

The stock market crash of 1929

On October 24, 1929, investors started to sell overpriced shares in large numbers. The stock market crash that some had anticipated finally occurred. On the day now termed “Black Thursday,” investors traded a record of 12.9 million shares. After five days, on October 29 or “Black Tuesday,” around 16 million shares were traded, following another wave of panic overwhelming Wall Street. As a result, millions of shares became worthless, and investors with stocks “on margin” (bought with borrowed money) were wiped out.

Consumer confidence vanished in the aftermath of the stock market crash. The downturn in businesses slowed down production and began firing their employees. For people fortunate to remain employed, wages decreased, and consumption plummeted. Moreover, many Americans who had to buy on credit kept falling into debt, resulting in the number of foreclosures and repossessions steadily climbing. In addition, the global adherence to the gold standard, which joined countries worldwide in fixed exchange of currency, helped spread economic woes from the United States throughout the world, especially Europe.

Many believe that the stock market crash on Black Tuesday, October 29, 1929, is the same as the Great Depression. In reality, it was one of the major causes of the Great Depression. In the two months following the original crash in October, stockholders had lost more than $40 billion. Although the stock market began regaining some losses by the end of 1930, it was far from enough, and America truly entered the Great Depression. The stock market crash in 1929, also known as the Great Crash, was an alarming decline in U.S. stock market values that contributed to the Great Depression of the 1930s. The Great Depression lasted approximately ten years and affected both industrialized and nonindustrialized countries globally.

During the mid-to-late 1920s, the stock market in the U.S. expanded rapidly, continuing for the six months following President Herbert Hoover’s inauguration. Stock prices soared impressively during the great “Hoover bull market,” as the public rushed to brokers wanting to invest their liquid assets or savings in securities. Billions of dollars were flowing from the banks into Wall Street. During the midsummer of 1929, some 300 million shares of the stock were on margin, pushing the Dow Jones Industrial Average to peak at 381 points in September. Any warnings of the crumbling foundations of this financial house of cards went unheeded.

Prices began declining in September and early October. Still, speculation continued, fueled in many cases by individuals who had borrowed money to buy shares— the practice was sustainable only as long as stock prices continued rising. Then, on October 18, the market went into free fall, as the wild rush to buy stocks gave way to a frantic rush to sell. The first day of real panic came on October 24, or “Black Thursday,” when a record 12.9 million shares were traded as investors hurried to salvage the losses. The Dow managed to close down only six points after some big banks and companies bought up huge stock blocks, successfully stemming the panic for the day. However, their attempts to shore up the market ultimately failed.

The panic erupted again on Black Monday (October 28), as the market closed down 12.8%. On Black Tuesday (October 29), above 16 million shares were traded. The Dow lost another 12%, closing at 198. A drop of 183 points in only two months. Prime securities tumbled like issues of bogus gold mines. General Electric went from 396 to 210. American Telephone and Telegraph dropped 100 points. DuPont fell from 217 to 80, and Radio Corporation of America (RCA) from 505 to 26. At first, political and financial leaders treated the matter as just another market spasm, giving reassurances to one another. President Hoover and his Treasury Secretary Andrew W. Mellon led with predictions of a great revival of prosperity. However, although the Dow almost reached the 300 mark again in 1930, it dropped rapidly in May 1930. Two decades would pass before the Dow could regain enough momentum to surpass the 200-point level.

Many factors contributed to the crash of the stock market. Among prominent causes was overwhelming speculation. People who had bought stocks on margin lost the value of their investment and also owed money to entities that had granted these loans for stock purchases), credit tightening by the Federal Reserve (in August 1929, they raised the discount rate from 5 – 6%).

The collapse of the world trade

As businesses began to crumble, the Government created the Smoot-Hawley Tariff in 1930 to help protect American companies. Unfortunately, this charged a high import tax, leading to less trade between America and foreign countries and economic retaliation.

Since demand was declining and big business and agriculture, feeling the effect of cheap goods coming from abroad, lobbied for protection. Finally, Congress obliged and introduced the United States Tariff Act of 1930, the Smoot-Hawley bill, raising tariffs on foreign products by about 20%.

Multiple countries retaliated with tariffs on U.S. goods, causing a trade meltdown. In the next two years, U.S. imports fell 40%. No markets abroad, no demand at home. Little wonder that economic activity came to a standstill.

Government policies

The American economic system was structurally weak. Banks worked without guarantees to their customers, creating a climate of panic during tough times. The Government placed few regulations on banks that easily lend money to those gambling in stocks. Agricultural prices had been low during the 1920s; hence, the farmers could not spark any recovery. As a result, Europeans bought fewer American products when the Depression spread across the Atlantic. The American economy was shaking, and when President Hoover was inaugurated, he could not provide proper relief from hard times. His popularity decreased as more Americans lost jobs. His lazy approach to government intervention made a negligible impact. The economy shrank with each passing year of his Presidency. As middle-class Americans stood in the same lines previously consisting of only the Nation’s poorest, the entire social fabric of America was forever changed.

President Herbert Hoover’s responded to the economic crisis with incompetence. A believer in minimal government intervention, he disregarded direct public relief as character-weakening. However, he eventually started spending and launched lending and public works projects. But it was too little, too late.

Bank panics & failures

From 1930 to 1932, the U.S. experienced four extended waves of panic in banking, during which bank customers feared bank solvency and tried withdrawing their deposits in cash. As a result, 1/5th of the banks existing in 1930 had failed by 1933. As a result, the Franklin D. Roosevelt administration declared a four-day “bank holiday” later extended by three days. The country’s banks remained closed until they proved their solvency to government inspection. The consequence of widespread bank failures was decreasing consumer spending and business investment because fewer banks could lend money. Also, there was less money to lend, partly because people were hoarding it in the form of cash. According to some scholars, the problem was exacerbated by the Federal Reserve. Which raised interest rates and deliberately reduced the money supply with the belief that it was necessary to maintain the gold standard for the U.S. and many other countries to associate the value of their currencies to a fixed amount of gold. The reduced money supply, in turn, reduced prices, which further discouraged lending and investment (because people feared that future wages and profits would not be sufficient to cover loan payments).

The collapse of the money supply

Ultimately, the decrease in money supply led to deflation. That, in turn, caused sky-high increases in actual interest rates, which choked off any chances of companies investing or expanding. As a result, unequal distribution of wealth became one of the major causes of the Great Depression. The consequences of this unfair distribution of resources impacted those who were the most vulnerable financially and those who had to give up on their elite status following insurmountable losses.

While corporate profits skyrocketed, wages increased incrementally, widening the distribution of wealth. The wealthiest 1% of Americans owned over a third of all American assets—such concentration of wealth in the hands of a few limited economic developments. The rich tended to save money that might have been put back into the economy if spread among the middle and lower classes. Middle-class Americans had already stretched their debt capacities by purchasing automobiles and household appliances on installment plans.

Underconsumption & overproduction

With the stock market crashing and fears of further economic woes, individuals from all classes stopped buying items, reducing the number of items produced and thus a reduction in the workforce. As people lost their jobs, they could not keep paying for things they had bought through installment plans, resulting in repossession of these items. As a result, more inventory began to accumulate. The unemployment rate went above 25%, which meant, of course, even less spending to help alleviate the economic situation.

Mass production catalyzed the consumption boom in the 1920s. But unfortunately, it also resulted in overproduction on the part of many businesses. So even before the crash, they started selling products at losses.

A similar crisis occurred in agriculture. During the first World War, farmers bought machinery to boost production — this proved to be a costly move that indebted them. In the post-war economy, they produced far more supply than consumers needed. As a result, land and crop values plummeted, causing a drop in agricultural and industrial prices that decimated profits and hurt already over-extended enterprises.

World war 1

The lingering impact of World War I (1914-1918) caused economic woes in many countries. And as Europe struggled to pay war debts and reparations. Their financial problems contributed to the crisis that began the Great Depression, the worst economic disaster in American history.

What happened during the Great Depression?

During the peak of the Great Depression in 1933, nearly a quarter of the Nation’s total workforce, almost 13 million people, were unemployed. Wage income for workers who were fortunate to have kept their jobs fell nearly 43% from 1929 to 1933. It was the worst economic disaster in U.S. history.

Farm prices fell so rapidly that many farmers lost homes and land. Many went hungry. Families had to split up or migrate from their homes, searching for jobs. ‘Hoovervilles’ (insultingly named after President Hoover), shanty towns constructed of packing crates, abandoned cars, and other cast-off scraps spawned all over the Nation. Gangs of youths rode the rails in boxcars like the many hoboes desperate to find jobs. Victims of drought and dust storms in the Great Plains left their farms and headed to California, the new land of “milk and honey,” where they believed all one had to do was reach out and pluck food from the trees. America’s unemployed were on the move, but there was nowhere to go. The Depression severely shook the industry. Businesses closed, mills and mines were abandoned, fortunes were lost. American business and labor were both in trouble.

How did the Great Depression end?

President Hoover believed the Government should not directly intervene in the economy as it was not responsible for creating jobs or providing economic relief to the citizens. In 1932, the country mired in the depths of the Great Depression, and Democrat Franklin D. Roosevelt won in the presidential election with an overwhelming victory. By Inauguration Day (March 4, 1933), the U.S. Treasury didn’t have enough cash to pay all the government employees. Nonetheless, FDR projected a calm optimism. Roosevelt took immediate steps in addressing the economic challenges. First, he announced a four-day “bank holiday” so that Congress could reopen those banks when they were determined to be sound. He began addressing the public directly in a series of talks over the radio. These “fireside chats” contributed towards restoring public confidence in the administration. During FDR’s first 100 days in office, his administration passed legislation stabilizing industrial and agricultural production, creating jobs and stimulating recovery. In addition, Roosevelt aspired to reform the financial system, introducing the Federal Deposit Insurance Corporation (FDIC) to protect depositor accounts and the Securities and Exchange Commission (SEC) that would regulate the stock market to prevent abuses of the kind that led to the 1929 crash.

Among the initiatives of the New Deal aiding in recovery from the Great Depression was the Tennessee Valley Authority (TVA). TVA built dams and hydroelectric projects to channel flooding and provided electricity to the impoverished Tennessee Valley region of the South and Works Project Administration (WPA), which employed 8.5 million Americans from 1935 to 1943. After showing signs of recovery beginning in 1933, the economy continued to improve throughout the next three years. GDP (adjusted for inflation) grew at the average rate of 9% per year. Then, a recession hit in 1937, caused partly by the Federal Reserve due to its decision to increase requirements for money in reserve. Although the economy began improving in 1938, the second severe contraction had reversed many of the gains in production and employment, prolonging the effects of the Great Depression. In addition, depression-era hardships fueled the rise of extremist political movements across Europe, most notably that of Adolf Hitler’s Nazi regime in Germany. German aggression led the war to break out in Europe in 1939. As a result, WPA turned its attention to strengthening U.S. military infrastructure, even as it maintained neutrality. With Roosevelt’s decision to support Britain and France against Germany and other Axis Powers, defense manufacturing increased, producing more private-sector jobs. The attack on Pearl Harbor from Japan in December 1941 led to America declaring war, and U.S. factories went back in full production mode. This expanding industrial production and widespread conscription beginning in 1942 reduced the unemployment rate to below its pre-Depression level.

Effects of the Great Depression

The Great Depression lasted almost ten years (from late 1929 until about 1939) and affected nearly every country in the world. It was marked by gradual declines in industrial production and deflation, mass unemployment, banking panic, and alarming increases in rates of poverty and homelessness. For example, in the United States, from 1929 to 1933, industrial production fell nearly 47%, GDP declined by 30%. In comparison, during the Great Recession of 2007–09, the second-largest economic downturn in American history, GDP fell by 4.3%.

After becoming President, Franklin D. Roosevelt started pushing through Congress a series of programs and projects called the New Deal. How much the New Deal alleviated the situation is a matter of debate. In the following decade, production remained low, and unemployment was high. However, the New Deal did more than attempt to stabilize the economy, provide relief to jobless Americans and create previously unheard-of social security plans, and regulate the private sector. It reshaped the role of Government, with programs that are now part of the fabric of American society.

The effects of the Great Depression were disastrous, like widespread hunger, poverty, and unemployment. The economic crisis was worldwide. Not only did it lead to the Democratic victory in the 1932 election and the New Deal in the U.S., but more crucially, it was a direct cause of the rise in extremism in Germany, leading to the 2nd World War.

Conclusion

Remember how Quentin Tarantino movies end with cutesy songs in the context of terrible events? Here are song lyrics summing up the bizarrely disastrous turn of events that almost brought the industrialized world to a halt.

“Once I built a railroad, I made it run.

I made it race against time.

Once I built a railroad, now it’s done.

Brother, can you spare a dime?”

“The highest unemployment rate since the Great Depression” read headlines in April 2020, when the unemployment level hit 14.7% of U.S. citizens. (It declined overall since, but it troublingly remains in double-digits among Blacks and Hispanics). Consider these grim statistics in the coronavirus era: From February 12 to March 30, 2020, the DJIA declined 35%. In the second quarter of 2020, GDP dropped at a 32.9% annualized rate, the sharpest decline since 1947. There is absolutely a depression among certain underprivileged groups, but is another Great Depression possible?

Though there’s no consensus, many economists argue that another such catastrophe, at least one caused by internal factors, is unlikely. That’s mainly because the current federal government can draw on more policy and monetary tools, ranging from unemployment compensation to controlling the money supply. As, indeed, it has done. Consider the Great Recession of 2007-2009, for example. I was also catalyzed by a financial-market crisis: the subprime loan meltdown. And the Fed quickly slashed interest rates. The downturn lasted less than two years. The economy recovered, eventually sparking a record-breaking bull market.

Memories of the Great Depression will never fade. But Brad Cornell, managing director of Berkeley Research Group, says, “we know enough and can respond quickly enough so that these sorts of endogenous downward spirals are not going to happen again.”

Tony Bennett

Tony Bennett

Tony Benett makes his living in the insurance industry by teaching and consulting. He is also recognized by the legal profession as an expert on insurance coverages. His insurance experience includes having worked at the company level, owned an independent general agency and having worked for an insurance association. He has received various certificates over the past few years and helps his clients and readers by giving them a realistic outlook on what they can expect to achieve within their set targets. At Insurance Noon, he is known for his in-depth analysis and attention to details with accuracy. He has been published as one of the most referred agents by his peers in the insurance community. Tony loves the outdoors and most sport events. His passion other than providing excellent advice is playing golf.