Learning Objectives
- Assess the causes and underlying weaknesses in the economy that resulted in America’s spiraling from prosperity into the Great Depression
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.
Link to Learning
Visit this website to see a visual representation of the causes and effects of the Great Depression.
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.
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This video describes the events leading up to the Great Depression and the different roles that consumers and banks played in the stock market crash.
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The Aftermath
Figure 1. As the financial markets collapsed, hurting the banks that had gambled with their holdings, people began to fear that the money they had in the bank would be lost. This began bank runs across the country, a period of still more panic, where people pulled their money out of banks to keep it hidden at home.
After the crash, Hoover announced that the economy was “fundamentally sound.” On the last day of trading in 1929, the New York Stock Exchange held its annual wild and lavish party, complete with confetti, musicians, and illegal alcohol. The U.S. Department of Labor predicted that 1930 would be “a splendid employment year.” These sentiments were not as baseless as they may seem in hindsight. Historically, markets cycled up and down, and periods of growth were often followed by downturns that corrected themselves. But this time, there was no market correction; rather, the abrupt shock of the crash was followed by an even more devastating depression. Investors, along with the general public, withdrew their money from banks by the thousands, fearing the banks would go under. The more people pulled out their money in bank runs, the closer the banks came to insolvency, unable to pay their debts.
The contagion effect of the crash grew quickly. With investors losing billions of dollars, they invested very little in new or expanding businesses.
Figure 2. As the Great Depression set in, thousands of unemployed men lined up in cities around the country, waiting for a free meal or a hot cup of coffee.
The needy drew down whatever savings they had, turned to their families, and sought out charities for public assistance. Soon these resources were depleted. Unemployed workers and cash-strapped farmers defaulted on their debts, including their mortgages. Already overextended banks, deprived of income, took savings accounts down with them when they closed. Fear-stricken observers went to their own banks and demanded their deposits. Banks that otherwise might have endured the crisis fell prey to panic, and shut down as well.
With so little being bought and sold, and so little loaned and spent, with even bankers unable to lay their hands on money, the nation’s economy ground nearly to a halt.
The New Reality for Americans
For most Americans, the crash affected daily life in myriad ways. In the immediate aftermath, there was a run on the banks, where citizens took their money out if they could, and hid it under mattresses, in bookshelves, or anywhere else they felt was safe. Some went so far as to exchange their dollars for gold that they could ship out of the country. A number of banks failed outright, and others, in their attempts to stay solvent, called in loans that people could not afford to repay. Working-class Americans saw their wages drop: Even Henry Ford, the champion of a high minimum wage, began lowering wages by as much as a dollar a day. Southern cotton planters paid workers only twenty cents for every one hundred pounds of cotton picked, meaning that the strongest picker might earn sixty cents for a fourteen-hour day of work. Cities struggled to collect property taxes and subsequently laid off teachers, police, and other public sector employees.
The new hardships that people faced were not always immediately apparent; many communities felt the changes but could not necessarily look out their windows and see anything different. Men who lost their jobs didn’t stand on street corners begging; they disappeared. They might be found keeping warm by a trashcan bonfire or picking through garbage at dawn, but mostly, they stayed out of view. As the effects of the crash continued, however, the results became more evident. Those living in cities grew accustomed to seeing long breadlines of unemployed men waiting for a meal. Companies fired workers and tore down employee housing to avoid paying property taxes. The landscape of the country had changed.
Comparisons to The Great Recession
From 2007-2009, there was a global economic recession that has been categorized as the worst financial crisis since the Great Depression. The causes of this recession were extremely complicated, but it was partially caused by predatory mortgage lending and the activities of large financial institutions that took advantage of low interest rates. Unemployment hit around 10% (it peaked at around 25% during the Great Depression) and more than 3.8 million Americans lost their homes to foreclosure. In the end, the U.S. government passed a “bail-out” bill which provided around $700 billion to stabilize the banks and other financial institutions that had actually caused the crisis to begin with.