Causes of the Depression

The crash both stunned the nation and exposed some of the deeper, underlying problems in the American economy of the 1920s. The stock market’s popularity grew throughout the decade, but only 2.5 percent of Americans had brokerage accounts; the overwhelming majority of Americans had no direct personal stake in Wall Street. The stock market’s collapse, no matter how dramatic, did not by itself depress the American economy. Instead, the crash revealed a great many factors that, when combined with the financial panic, pushed the economy into a state of crisis. Rising inequality, declining demand, rural collapse, overextended investors, and the bursting of speculative bubbles all contributed to the Great Depression.

The crash also represented both the end of an era characterized by blind faith in American exceptionalism and the beginning of one in which citizens began to question long-held American values. Many elements contributed to the downward trend in the market, which continued well into the 1930s. In addition to the Federal Reserve’s questionable policies and misguided banking practices, some of the primary reasons for the collapse of the stock market were international economic woes, a saturated consumer market, poor income distribution, and the mass psychology of public confidence.

International Economic Woes

After World War I, both America’s allies and the defeated nations of Germany and Austria contended with disastrous economies. The Allies owed large amounts of money to U.S. banks, which had advanced them loans during the war. Unable to repay these debts, the Allies looked to reparations from Germany and Austria to help. The economies of those countries, however, were struggling badly, despite the loans that the U.S. provided to assist with their payments. The U.S. government refused to forgive these loans, and American banks were in the position of extending additional private loans to foreign governments, who used them to repay their debts to the U.S. government, essentially shifting their obligations to private banks. When other countries began to default on this second wave of private bank loans, still more strain was placed on U.S. banks, which soon sought to liquidate these loans at the first sign of a stock market crisis.

A Saturated Market

The pro-business policies of the 1920s were designed for an American economy built on the production and consumption of durable goods. Yet by the late 1920s, much of the market was saturated, meaning product supply exceeded demand. The boom of automobile manufacturing, the great driver of the American economy in the 1920s, slowed as there were fewer and fewer Americans with the means to purchase a car that had not already done so. Increasingly, the well-to-do had no need for the new automobiles, radios, and other consumer goods that fueled gross domestic product (GDP) growth in the 1920s. When products failed to sell, inventories piled up, manufacturers scaled back production, and companies fired workers, stripping potential consumers of cash, blunting demand for consumer goods, and replicating the downward economic cycle. The situation was only compounded by increased automation and rising efficiency in American factories. Despite impressive overall growth throughout the 1920s, unemployment hovered around 7 percent throughout the decade, suppressing purchasing power for a great swath of potential consumers.^[1]

Income Inequality

Despite resistance by progressives, the vast gap between rich and poor accelerated throughout the early twentieth century. In the aggregate, Americans were better off in 1929 than in 1920. Per capita income had risen 10 percent for all Americans, but 75 percent for the nation’s wealthiest citizens.^[2] The return of conservative politics in the 1920s reinforced federal fiscal policies that exacerbated the divide: low corporate and personal taxes, easy credit, and depressed interest rates overwhelmingly favored wealthy investors who, flush with cash, spent their money on luxury goods and speculative investments in the rapidly rising stock market.

Poor income distribution among Americans compounded the problem. A strong stock market relies on today’s buyers becoming tomorrow’s sellers, and therefore it must always have an influx of new buyers. In the 1920s, this was not the case. Eighty percent of American families had virtually no savings, and only one-half to 1 percent of Americans controlled over a third of the wealth. This scenario meant that there were no new buyers coming into the marketplace, and nowhere for sellers to unload their stock as the speculation came to a close. In addition, the vast majority of Americans with limited savings lost their accounts as local banks closed, and likewise lost their jobs as investment in business and industry came to a screeching halt.

The Mass Psychology of Public Confidence

Finally, one of the most important factors in the crash was the contagion effect of panic. For much of the 1920s, the public felt confident that prosperity would continue forever, and therefore, in a self-fulfilling cycle, the market continued to grow. But once the panic began, it spread quickly and with the same cyclical results; people were worried that the market was going down, they sold their stock, and the market continued to drop. This was partly due to Americans’ inability to weather market volatility, given the limited cash surpluses they had on hand, as well as their psychological concern that economic recovery might never happen.