Great Depression
The Great Depression was a global economic slump that began in the United States following Black Thursday, the Wall Street panic of October 1929. On October 24, 1929, share prices on Wall Street collapsed catastrophically, setting off a chain of bankruptcies and defaults that quickly spread overseas. The events in the United States triggered a worldwide depression, which put hundreds of millions out of work across the capitalist world throughout the 1930s.
The market crash in the U.S. was the final straw for the already shaky world economy. Germany was suffering from hyperinflation, and many of the Allied victors of World War I were having serious problems paying off huge war debts. In the late 1920s, the U.S. economy at first seemed immune to the mounting troubles, but with the start of the 1930s it crashed with startling rapidity.
Causes of the Great Depression
International finance never recovered from the strains of World War I, which caused a dramatic increase in productive capacity, particularly outside Europe, without a corresponding increase in sustained demand. Fixed exchange rates and free convertibility gave way to a compromise—the gold standard—that lacked the stability to rebuild world trade.
In 1929 the world's most prosperous nation was the United States. But despite the confidence in the United States and the apparent economic well-being in other countries, the world economy was in an unhealthy state. One by one, the pillars of the prewar economic system—multilateral trade, the gold standard, and the interchangeability of currencies—began to crumble.
The UK had returned to the gold standard in 1925 but had spent the previous five years managing the gold price down to its pre-war level. This forced a sharp deflation across the economy of the UK and the many other nations that used the Pound Sterling as their national unit of account.
The U.S. economy had been showing some signs of distress for months before October 1929. Commodity prices had been falling worldwide since 1926, reducing the capacity of exporters in the peripheral, undeveloped economies of Latin America, Asia, and Africa to buy products from the core industrial countries such as the United States and the United Kingdom. Business inventories were three times as large as they had been a year before (an indication that the public was not buying products as rapidly as in the past); and other indicators of economic health—freight carloads, industrial production, wholesale prices—were slipping downward.
A maldistribution of purchasing power
A fundamental maldistribution of purchasing power, the greatly unequal distribution of wealth throughout the 1920s, was another factor that contributed to the Great Depression. Wages increased at a rate that was a fraction of the rate at which productivity increased. As production costs fell quickly, wages rose slowly, and prices remained constant, the bulk benefit of the increased productivity went into profits. As industrial and agricultural production increased, the proportion of the profits going to farmers, factory workers, and other potential consumers was far too small to create a market for goods that they were producing. Even in 1929, after nearly a decade of economic growth, more than half the families in America lived on the edge or below the subsistence level—too poor to share in the great consumer boom of the 1920s, too poor to buy the cars and houses and other goods the industrial economy was producing, too poor in many cases to buy even the adequate food and shelter for themselves. As long as corporations had continued to expand their capital facilities (their factories, warehouses, heavy equipment, and other investments), the economy had flourished. Thanks to pressure from the Coolidge administration and the business, the Federal Reserve Board kept the rediscount rate low, encouraging excessive investment. By the end of the 1920s, however, capital investments had created more plant space than could be profitably used, and factories were producing more goods than consumers could purchase.
An increase in margin buying, the act of borrowing money from lenders in order to buy stocks, helped many people invest in the roaring stock market of the 1920s. When the stock market began to decline, the lenders panicked and demanded their money back. This increased the sales of stocks to pay off the loans, but many people remained in debt and the lenders could not get their money back.
A lack of diversification
Another factor was the serious lack of diversification in the American economy of the 1920s. Prosperity had been excessively dependent on a few basic industries, notably construction and automobiles; in the late 1920s, those industries began to decline. Between 1926 and 1929, expenditures on construction fell from $11 billion to under $9 billion. Automobile sales began to decline somewhat later, but in the first nine months of 1929 they declined by more than one third. Once these two crucial industries began to weaken, there was not enough strength in the other sectors of the economy to take up the slack. Even while the automotive industry was thriving in the 1920s, some industries, agriculture in particular, were declining steadily. While the Ford Motor Company was reporting record assets, farm prices plummeted, and the price of food fell precipitously.
Postwar deflationary pressures
During World War I many European nations abandoned the gold standard in an attempt to use inflationary policies to fund wartime expenditures. This had a number of economic consequences in its own right. However what is of particular relevance is that following the war most nations returned to the gold standard at the pre-war gold price. Monetary policy was in effect put into a deflationary setting that would over the next decade slowly grind away at the health of many European economies. Modern advocates of the gold standard, such as proponents of supply-side economics, maintain that the correct policy following World War I would have been to return to the gold standard at the prevailing market price of gold rather than at the pre-war price.
Deflation's impact is particularly hard on sectors of the economy that are in debt. Deflation erodes the price of commodities while increasing the real value of debt. One typical group that is adversely affected is the farm sector.
It should be noted, however, that deflationary forces alone do not fully account for the Great Depression and must be considered in the context of other factors.
The credit structure
Farmers, already deeply in debt, saw farm prices plummet in the late 20s, their implicit real interest rates on loans skyrocket; their land was already mortgaged, and crop prices were too low to allow them to pay off what they owed. Small banks, especially those tied to the agricultural economy, were in constant crisis in the 1920s as their customers defaulted on loans due to the sudden rise in real interest rates; there was a steady stream of failures among these smaller banks throughout the decade.
Although most American bankers in this era were staunchly conservative, some of the nation's largest banks were failing to maintain adequate reserves and were investing recklessly in the stock market or making unwise loans. In other words, the banking system was not well prepared to absorb the shock of a major recession. The banking system as a whole, moreover, was only very loosely regulated by the Federal Reserve System at this time.
The breakdown of international trade
Another factor contributing to the Great Depression was America's position in international trade. Protectionist impulses would drive nations to protect domestic production against competition from foreign imports by erecting high tariff walls. The Hawley-Smoot Tariff Act of June 1930 raised U.S. tariffs to unprecedented levels. It practically closed U.S. borders and, with retaliatory tariffs from U.S. trading partners, caused the immediate collapse of the most important export industry, American agriculture. American foreign trade seriously declined, and the volume of world trade steadily decreased.
Prior to the Great Depression, a petition signed by over 1000 economists was presented to the U.S. government warning that the Hawley-Smoot Tariff Act would bring disastrous economic repercussions, however, this did not stop the act from being signed into law.
Beginning late in the 1920s, European demand for U.S. goods began to decline. That was partly because European industry and agriculture were becoming more productive, and partly because some European nations (most notably Weimar Germany) were suffering serious financial crises and could not afford to buy goods overseas. However, the central issue causing the destabilization of the European economy in the late 1920s was the international debt structure that had emerged in the aftermath of World War I.
When the war came to an end in 1918, all European nations that had been allied with the United States owed large sums of money to American banks, sums much too large to be repaid out of their shattered treasuries. This is one reason why the Allies had insisted (to the consternation of the perhaps historically vindicated Woodrow Wilson) on demanding reparation payments from Germany and Austria. Reparations, they believed, would provide them with a way to pay off their own debts. But Germany and Austria were themselves in deep economic trouble after the war; they were no more able to pay the reparations than the Allies were able to pay their debts.
The debtor nations put strong pressure on the United States in the 1920s to forgive the debts, or at least reduce them. The American government refused. Instead, U.S. banks began making large loans to the nations of Europe. Thus debts (and reparations) were being paid only by augmenting old debts and piling up new ones. In the late 1920s, and particularly after the American economy began to weaken after 1929, the European nations found it much more difficult to borrow money from the United States. At the same time, high U.S. tariffs were making it much more difficult for them to sell their goods in U.S. markets. Without any source of revenues from foreign exchange with which to repay their loans, they began to default.
The high tariff walls critically impeded the payment of war debts. As a result of high U.S. tariffs, only a sort of cycle kept the reparations and war-debt payments going. During the 1920s the former allies paid the war-debt installments to the United States chiefly with funds obtained from German reparations payments, and Germany was able to make those payments only because of large private loans from the United States and Britain. Similarly, U.S. investments abroad provided the dollars, which alone made it possible for foreign nations to buy U.S. exports.
By 1931 the world was reeling from the worst depression of all time, and the entire structure of reparations and war debts collapsed.
In the scramble for liquidity that followed the Great Crash, funds flowed back from Europe to America and Europe's fragile economies crumbled.
Responses
The Wall Street crash had ushered in a world-wide financial crisis. In the United States between 1929 and 1933 unemployment soared from approximately 3 percent to 25 percent, while manufacturing output declined by one-third. Governments worldwide sought economic recovery by adopting restrictive autarkic policies (high tariffs, import quotas, and barter agreements) and by experimenting with new plans for their internal economies.
The economic crises due to the depression were a terrible epidemic throughout the United States and many parts of the world. Consumers reduced their purchases of luxury cars, clothes, and many businesses cut production. Big businesses such as General Motors saw their sales drop by 50% in the late 1920s and the early 1930s. This caused businesses to lay off thousand of workers.
When the farm prices fell; small farmers went bankrupt and lost their land. By June of 1932, the American economy had fallen by about 55% of the work force. The Government tried to restore prosperity by spending on welfare and public works.
After the stock market collapse, the New York banks became frightened and called in their loans to Germany and Austria. However, without the American money, Germans had to stop paying reparations to France and Britain. Of course, this was a chain reaction and they could not repay their war loans to America. Therefore, the depression had spread to Europe. All governments were forced to cancel both reparations payments and war loans.
The United States government tried to protect domestic industries from foreign competition by imposing the highest import duty in American history. In retaliation, other countries raised their tariffs on imports of American goods. As a result, global industrial production declined by 36% between 1929 and 1932, while world trade dropped by a breathtaking 62%.
In 1932, the United States had elected President Franklin D. Roosevelt. He proposed the "New Deal", a platform of government programs to stimulate and revitalize the economy. The British and French governments also intervened in their economies and escaped the worst of the depression. Moreover, the Soviet Union put in the five-year plans.
Observers throughout the world saw in the massive program of economic planning and state ownership of the Soviet Union what appeared to be a depression-proof economic system and a solution to the crisis in capitalism.
In Germany unemployment increased drastically, fueling widespread disillusionment and anger. The institutions of the Weimar Republic, which had already been standing on shaky ground, started cracking in the years from 1930 to 1932, while Chancellor and finance expert Heinrich Brüning was trying to fix the economy by drastically cutting state spending. At the time, the NSDAP gained much popularity, winning the two general elections in 1932, which eventually led to the appointment of Adolf Hitler as Chancellor on January 30, 1933. (See Weimar Republic for details.) In Nazi Germany economic recovery was pursued through rearmament, conscription, and public works programs. In Mussolini's Italy the economic controls of his corporate state were tightened.
In the United Kingdom, the Labour government of Ramsay MacDonald, and later the Conservative-dominated "National Government" responded to the depression by imposing tariffs on all imports except those of the British Empire (which arguably worsened the global situation), by cutting public spending, and by abandoning the Gold Standard which reduced the cost of British exports. (see Great Depression in the United Kingdom).
As the U.S. and international economy crashed in the 1920’s, the self-correction of the economy was put into question.
In response, Herbert Hoover became the first Keynesian President – even before Keynes published “The General Theory” (however, in the 1920’s, Keynes did publish many other books, essays and articles promoting his ideology). During the 1932 elections, Franklin Delano Roosevelt blasted the Republican incumbent for spending and taxing too much, increasing national debt, raising tariffs and blocking trade, as well as placing millions on the dole of the government. He attacked Herbert Hoover for "reckless and extravagant" spending, of thinking "that we ought to center control of everything in Washington as rapidly as possible," and of leading "the greatest spending administration in peacetime in all of history." Roosevelt's running mate, John Nance Garner, accused the Republican of "leading the country down the path of socialism".
Between 1930 and 1931, government spending increased from 16.4% to 21.5%. To pay for it, in 1932, Hoover raised taxes. Most Americans saw their tax rates double, with the top rate rising from 24% to 63% (more than 2.5 times). As a direct result of the tax hike, unemployment immediately jumped more than 2% to near 30%.
Franklin Roosevelt ran on a platform that called for a 25-percent reduction in federal spending, a balanced federal budget, decreased government regulation of the private enterprise, and an end to the "extravagance" of Hoover's farm programs. Yet despite calling the above promises “a covenant” during the 1932 elections, FDR and his VP built on Hoover’s policies. Rexford Guy Tugwell, one of the architects of Franklin Roosevelt's policies of the 1930s, admitted, "We didn't admit it at the time, but practically the whole New Deal was extrapolated from programs that Hoover started."
The new administration, however, did sharply reverse course on the monetary policy, reducing the value of the dollar by 40%, causing sharp inflation, which is just as undesirable as deflation. [14] The FDR inflation did not resolve the Hoover problem of under-consumption and over-production since many business already closed doors or fired employees and/or got rid of their reserve at any price (afterall, their goods were being devalued daily in Hoover’s deflationary environment). So rather than help business, FDR inflation merely harmed consumers and shocked the economy. Furthermore, people quickly realized that their money are being devalued and ran to the bank to withdraw everything they had for immediate consumption. This and the surrounding economic depression caused several banks to go bankrupt, leading to a popular panic about the safety of investments and savings. The panic caused more people to withdraw money from banks, causing more harm to the economy.
Roosevelt’s response was to increase taxes and spending. In the first year of the New Deal, Roosevelt proposed spending $10 billion while revenues were only $3 billion. Between 1933 and 1936, the federal government’s expenses increased by over 83 percent. Federal debt skyrocketed by 73 percent. FDR’s 1933 minimum wage requirements caused 550,000 African-Americans alone to lose their jobs.
Roosevelt engaged in multiple tax increases, resulting in the highest income tax rate standing at 90%. In 1941, FDR proposed a tax of 99.5% on all income over $100,000. When Congress refused, the President issued on August 27, 1942 an executive order imposing a 100% (one-hundred percent) income tax on all income over $25,000. [18] In November 1942, Republicans won the mid-term elections and passed a law against the Democrat’s executive order (a statute passed by Congress and either signed by the President or over the President’s veto is supreme to the President’s executive order, as per United States Constitution).
Yet, tax increases by Hoover and Roosevelt did not produce increased tax revenue. In 1929, 98% of Americans did not pay income tax and income tax rates for the top 2% ranged from 0.5% to 24%. By 1935, tax exemptions were lowered so that almost all workers paid taxes ranging from 5% to 79%. Yet, revenue from income tax down from almost $1.1 billion to $0.527 billion! [20] The upper class either stopped investing, or began investing oversees or in tax-exempt products. So while the “working class” had to toil for increasingly lower take-home wages, constantly subject to salary decreases due to tax hikes, the wealthy elites simply stashed their money away and either changed investments or lived off of interest. The rich don’t need to pay taxes – they can simply stop investing if it is not worth their time and effort. The working class needs to keep working and keep paying higher taxes. Since the rich have so much more than the poor, tax revenue necessarily decreases.
But the government needed money to pay for all the jobs it was “creating.” Unable to tax investments and unable to collect enough revenue by taxing the working class, the FDR administration skyrocketed taxation on consumer goods, from cars to food. As a result, excise taxes on goods brought increasingly high revenue, rising from $500 million in 1929 to $1.36 billion in 1935. Sales taxes are necessarily regressive and harm the poor the most. Afterall, $100 in sales taxes paid by a person earning $10,000 constitutes 1% of the person’s salary, while at the same time $100 constitutes only 0.1% of the salary earned by a person making $100,000. Thus, rather than helping the poor and the working class, tax raises were implemented on them, while the wealthy were simply forced to find different ways to invest.
Secretary of the Treasury Henry Morganthau admitted in May 1939, "We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and now if I am wrong somebody else can have my job. I want to see this country prosper. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises. I say after eight years of this administration, we have just as much unemployment as when we started. And enormous debt to boot."
Life during the Depression
In the so-called Dust Bowl, a massive area of the great plains consisting mainly of Kansas, Oklahoma, and parts of Texas, people found themselves unable to make a living. On top of the economic crisis, the earth withered and blew away in a series of massive dust storms. For a farming people this was disastrous, and these migrants were led westward by advertisements for work put out by agribusiness in western states such as California. The migrants came to be called Okies, Arkies, and other derogatory names as they flooded the labor supply of the agricultural fields, driving down wages and increasing competition for jobs in a place that couldn't afford it. This story was dramatized in the famous novel The Grapes of Wrath by John Steinbeck.
International
Many other nations, although not all, experienced a similar decline, though the severity and timing differed from country to country. For example, Britain hit its trough in the third quarter of 1932, while France did not reach its low point until April of 1935.
End of the Great Depression
For details, see the main New Deal article.
It was not until the U.S. entered World War II that Roosevelt's ideas for massive public expenditures and deficit spending truly began to bear fruit. Roosevelt's administration, of course, had little choice but to increase expenditures, given the war effort. Even given the special circumstances of war mobilization, New Deal policies seemed to work exactly as predicted, winning over many Republicans, who had been the New Deal's greatest opponents. When the Great Depression was brought to an end by the Second World War, it was obvious that the turnaround had been caused primarily by the reinforcement of business through government expenditure.
New Deal programs sought to stimulate demand and provide work and relief for the impoverished through increased government spending: the theories behind the New Deal were backed up later by the writings of British economist John Maynard Keynes. In 1929 federal expenditures constituted only 3 percent of the GDP. Between 1933 and 1939, federal expenditure tripled, and Roosevelt's critics accused him of turning America into a socialist state.
However, spending on the New Deal was far smaller than on the war effort. In the first peacetime year of 1946, federal spending still amounted to $62 billion, or 30 percent of GDP. In short, federal expenditures went from 3 percent of the GDP in 1929 to about a third in 1945. The big surprise was just how productive America became: spending financially cured the depression. Between 1939 and 1944 (the peak of wartime production), the nation's output more than doubled. Consequently, unemployment plummeted—from 19.0 percent in 1938 to 1.2 percent in 1944 as the labor force grew by ten million. The war economy was not so much a triumph of free enterprise as the result of government/business sectionalism, of the Federal government bankrolling business. While unemployment remained high throughout the New Deal years, consumption, investment, and exports—the pillars of economic growth—remained low. It was World War II, not the New Deal, which finally ended the crisis. Nor did the New Deal substantially alter the distribution of power within American capitalism; it had only a small impact on the distribution of wealth among the population (the effect of the war on this, however, was massive: the years immediately following the war played host to the narrowest wealth gap between rich and poor in American history, according to most estimates).
The Great Depression was not the longest depression on record, that title being held by the Long Depression of the late nineteenth century, nor was it the sharpest contraction, the one after the First World War being a deeper drop. It has commonly been described as the "deepest" depression in history as no other contraction was so deep for so long.