What are the Main Reasons Behind the Great Depression in 1929

Introduction

There are different views on what really caused the Great Depression in 1929. Some blame it on the weak banking system; some say over speculation, resulting in the Wall Street Crash. Others say it was the Federal Reserve’s wrongdoing for keeping interest rates low – making credit easily accessible. There are various reasons that contributed to the Great Depression; I will explore them in this essay.

Roaring 20s

For the past decade, America was in the “Roaring 20s”. They had been experiencing a prosperous time; they had just won World War I. There were a lot of technological advancements and inventions. More women got jobs – people had more disposable income to spend. American households now had access to electricity. There were now airplanes, radios and what was once luxury, now became normal goods. Mass consumption was taking place. How did the average folk afford all these goods? Through credit. The trend in the American society encouraged people to pay in instalments for these big-ticket items. However, this was unsustainable. The irrational behaviour of consumers lived in the moment and did not consider the future.

There was also an increasing trend in investing into the Stock Market. This is because after the War, the government issued Liberty Bonds - this presented the concept of financial securities to many citizens for the first time. At the time, investing in the stock market was respectable and reliable. People were willing to invest in order to make a profit. Charles Mitchell (president of National City Bank) saw this gap and decided to capitalise on this by opening brokerage offices across the US – allowing people to speculate in stocks and shares. This trend continued to rise, and large amounts of people joined in on this activity. By the mid-20s, 3m Americans were in the market. (1929: The Great Crash, 2009).

Fall in Consumer Confidence

Towards the end of the 20s, America grew wealthier as a country. American households had more money than ever before and everyone took out loans (since interest rates were low, making credit cheap) in order to consume the new inventions, such as the vacuum, radio, washing machine, Ford’s T-Model etc. Further, people also took out loans in order to invest in stocks. 90% of the purchase price of stocks in the bull market was being made with borrowed money. This increased the influx of borrowed money into the market, creating more demand for shares. The rise in prices lead to the market going up by almost 50% in just 12 months by 1928.

Hoover decided to intervene into the free market to reduce inflation. The Federal Reserve increased interest rates (Romer, 2003). He also ensured that worker’s wages were high. This helped spark the downfall of America. Banks no longer gave out loans to employers. The businesses had to do something to remain profitable, so in order to cut costs, they laid off workers. Consequently, unemployment rose and resulted in falling aggregate demand. Businesses continued producing as if there wasn’t a recession taking place – no one was purchasing these goods. Farmers had mechanised their production, so they became too efficient and overproduced. Since they took out huge loans earlier to purchase capital, their level of debt had increased. Demand for agricultural food dropped too as disposable income fell. Inventories in businesses built up and prices dropped further. Deflation was taking place. Over 60% of the population were living below the poverty line. Just 5% of the wealthiest classes received 33% of the nation’s income (Ali, 2016).

Wall Street Crash 1929

Between May and September 1929, 60 new companies were floated into the New York Exchange, with over 100m shares in the marketplace, fuelling the investment bubble. In September, the market became extremely volatile. Hoover asked his acquaintances from Wall Street if he should be concerned. Thomas Lamont, Senior Partner of JP Morgan assured him that there was nothing to worry about. However, on 24th October 1929, the Stock Market crashed. (1929: The Great Crash, 2009). Investors lost confidence; over 12 million shares were sold. The Stock Market bubble had burst. “Between their peak in September and their low in November, U.S. stock prices…declined by 33%” (Romer, 2003). This affected the whole economy as it depressed consumer spending, making people feel poorer.

The economy thought they had recovered, but 5 days later, on 29th October 1929, some of the largest US corporations saw their share price dramatically fall: US Steel and General Motors. These were the companies that thrived during the “Roaring 20s”. By the end of the day, stocks were worth 22% less than what they did in the past 36 hours. Roughly $25bn of wealth had vanished between this period (1929: The Great Crash, 2009). This crash is the result of over speculation in the stock market.

“In October the stock market crash made everyone realize that depression had truly arrived” (Rothband, 1963) p.163.

These series of events truly sparked the Great Depression as unemployment in the US reached an all-time high of 24.9%. People had invested their life savings and mortgaged their homes to purchase stocks in the market. They lost everything. (Duignan, 2019)

“The Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than by any inherent instability of the private economy.” (Friedman, 2009) p.38.

Weak Banking System and Federal Reserve

Another big factor that caused the Great Depression was the weak banking system in line with the idleness of the Federal Reserve. The crisis occurred when the HQ of Bank of US failed.

Fed was created on 23rd December 1913; its role is to supply cash to the banks to keep them solvent and to reassure the public that they could withdraw their money at any time. They could have easily saved the banks that crashed as they had more than enough power and information in order to do so. It was their responsibility to supply banks so that they had sufficient reserves to meet the demand of the depositors. In reality, people rushed to withdraw their money. Banks had insufficient reserves and so they crashed. This started a series of bank runs. (Green, 2013)

Why did the system not prevent the crash? The Federal Reserve reduced the money supply between 1929-1930. By December 1930, this had dropped to 3%. A growing economy requires additional money in order to prevent deflation. When the bank runs occurred, fed could have prevented disastrous consequences, by providing the banks with extra cash to satisfy depositors. If fed acted this way, stepped in and bought government securities on a large scale, the depositors would have found that their money was safe with the banks; thus, restoring confidence and a halt in withdrawing mass amounts.

From 1930 -1933, banks continued to crash as a result of a domino effect. By 1933, the quantity of money in the US had gone down by 1/3. The slow throttling had turned into strangulation. For every $3 of currency and deposits that people had had in 1929, only $2 were left. For every three banks that were open in 1929, in 1933, only 2 were left.

According to Friedman, “the terrible Depression that followed was a direct result of bungling by the Federal Reserve System”. Their monetary policies stifled any hope of economic recovery (Friedman & Friedman, 1980).

Conclusion

Although there are other contributing factors, the views that I have explored are some of the main reasons for causing the Great Depression. It is always easy to lay the blame on people. But evidently in this case, The Great Depression could have been prevented by the Federal Reserve. They already knew what to do to stop the catastrophic events from occurring. If only they had stepped up, taken responsibility for their duties and supported the banks, we would not be here discussing the Great Depression of 1929.