The pre-existing weaknesses had a larger bearing on the

The Great Depression was undoubtedly the most
severe economic downturn in the United States that lasted, with varying
severity, for ten years. It can be viewed that the collapse of the stock market
in 1929 was the predominant cause of the depression. However, there are other
weaknesses attributed to the cause of this event, for example the inequitable distribution
of income, poor corporate structure, the inadequacy of economic intelligence,
weak banking structure, the natural cycle of the economy and monetary
contraction by the Federal Reserve System. In what follows, each of these areas
will be discussed together with their relative responsibility for the Great
Depression. Finally, it will be argued that while the stock market collapse was
a contributory factor, other pre-existing weaknesses had a larger bearing on
the ensuing disaster.



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The collapse of the stock market in October
1929, otherwise known as the Wall Street Crash, is thought to be one of the
main causes of the Great Depression. Throughout the beginning of the 1920s,
employment and production were rapidly increasing; it was a “good time to be in
business” (Galbraith, 1954: p.31). This
economic growth created speculation in stocks, as many anticipated continually rising
share prices. This enabled companies to acquire money at low price and
therefore invest in their own production. However, this lead to overproduction in many areas and companies were
forced to dispose of their products at a loss, thus share prices began to fall
in September 1929. Despite the declining price, speculation continued and on
October 18th, the market spiralled downwards in a rush to sell
stocks. The crash itself occurred on October 29th,
the Dow had decreased by twenty-five percent from October 25th and investors
lost over thirty billion dollars.

to what had been Wall Street’s perceived tendency in deemphasising its role,
Galbraith (1954) asserted the significance of the stock market crash on the
Great Depression. The crash spread uncertainty, where hopes of a prosperous
future once prevailed, creating a sense of “utter hopelessness” (Galbraith,
1954: p.204). The destruction of confidence inhibited spending and therefore
reduced demand and production levels. Furthermore, the plummeting value of
stocks forced many companies into bankruptcy, which led to increasing
unemployment. The crash also ruined the normal method of investment and
lending, which hindered economic growth and caused financial hardship that alienated
many from the economic system, thus entrenching the United States in the Great
Depression. Therefore, to a certain extent, it can be shown that the collapse
of the stock market was responsible for the Great Depression.






NO –


On the contrary, it can be viewed that the
Wall Street Crash was not the predominant cause of the Great Depression; rather
there were pre-existing weaknesses in the economy that acted as more
significant contributory factors.


Bad distribution of income

In 1929, there was a vastly inequitable
distribution of income, which exacerbated the effects of the Wall Street Crash
and therefore contributed to the Great Depression. At the time of the crash,
the wealthy represented a vital proportion of the total population. Although output per
worker rose steadily during the period, wages and prices were relatively
stable. As a result, business profits increased rapidly, as did the incomes of
the wealthy. This suggests that the economy was heavily and increasingly
dependent on the luxury consumption of the well-to-do and their willingness to
reinvest what they did not spend on themselves.
Galbraith (1954: p.203) described them as the source of a “lion’s share” of
personal saving and investment. The Wall Street Crash signified a collapse in
security values, which first affected the affluent. Therefore, the shock to their
confidence resulted in broad, severe effects on expenditure and income in the
economy at large (Galbraith, 1954: p.203). If wealth had been distributed more
evenly, the average person would have been able to spend more and therefore the
demand for goods and services would not have declined so severely. Thus, due to
the unequal distribution of income, the effect of the Wall Street Crash was
greatly magnified and therefore acted as an important contributory factor
towards the Great Depression.



Bad corporate structure


The effects of the stock market crash were
worsened by the weaknesses in corporate structure, which further contributed to
the cause of the Great Depression. The most important corporate weakness was
inherent in the vast structure of holding companies and investment trusts
(Galbraith, 1954: p.195). This took a variety of forms, of which by far the most
common was the organisation of corporations to hold stock in yet more
corporations, which in turn held stock in further corporations. In
the case of the railroads and the utilities, the purpose of this pyramid was
that dividends from the operating companies paid the interest on the bonds of
upstream holding companies. Here, Galbraith (1954:
p.196) claimed was the “constant danger of devastation” by reverse leverage. He
states that the interruption of the dividends meant default on the bonds,
bankruptcy, and the collapse of the structure. For example, Montgomery Ward,
one of the prime speculative favourites of the period, dropped by 40% on Black
Thursday (put date) due to the vulnerability of its corporate structure.

Furthermore, in many cases, the great investment
trusts were organised to hold securities in other organisations in order to
manufacture more securities to sell to the public. During 1929, one investment
house, Goldman, Sachs & Company, organised and sold approximately a billion
dollars’ worth of securities in three interconnected investment trusts –
Goldman Sachs Trading Corporation; Shenandoah Corporation; and Blue Ridge
Corporation. All eventually depreciated to nothing during and after the crash. Galbraith
(1954: p.1960) remarked that it would be hard to imagine a corporate system
better designed to “accentuate a deflationary spiral.” Therefore, the poor
corporate structure at the time of the Wall Street Crash prompted many major
companies to retrench, which increased unemployment and thus contributed to the
cause of the Great Depression.



of economic intelligence/bad banking structure/gov’s inability to respond to
lack of demand (Keynes & Krugman)

Another factor that begot the Great
Depression was the inadequacy of economic intelligence. Classical economists,
such as Adam Smith (1759) believed that an ‘invisible hand’ guides the market
to regulate itself by means of competition, supply and demand, and
self-interest. If competition is allowed, the economy will automatically
gravitate towards full employment. However, Keynes (1939) challenged this view
and claimed that the economy is not always at full employment; it could rise
above or below full potential for a long time. During the Great Depression, consumption fell due to higher
rates of savings and thus the rate of interest also declined. According to the
classical economists, lower interest rates would lead to increased investment
and aggregate demand would remain constant. However, Keynes (1936) argued that investment
does not necessarily increase in response to a fall in the interest rate. For
example, if a fall in consumption appears to be long-term, as with the Great
Depression, then businesses will lower expectations of future sales. Therefore,
it would have been preferable to decrease investment in future production and
hence the economy is thrown into a slump. Keynes denied the self-correcting
mechanism and concluded that government intervention was necessary to end the

well-known phrase, “In the long run, we are all dead,” (1923: p.80) signifies that
the government should overcome issues in the short run, rather than wait for market
forces to resolve the economy in the long run. Furthermore, Keynes implied that
increased government spending would ‘prime the pump’ of the economy by
increasing aggregate demand and thus proliferating economic activity, which
would in turn reduce unemployment and alleviate the Great Depression.
Therefore, due to the government’s inability to respond to the lack of demand
at the time, the depression was aggravated and prolonged, and hence represented
a significant cause of the Great Depression.



supported by Krugman/bad banking structure

Furthermore, Krugman
(2013), as did Galbraith (1955), noted that the inherently weak banking structure
also played a role in causing the Great Depression. At
the start of the 1920s, new banks were opening at the rate of four to five per
day, leading to a large number of independent units. However, there were few
federal restrictions to determine how much start-up capital a bank needed or
how much of its reserves it could lend. As a result, most of these banks were
highly insolvent, and between 1923 and 1929, banks closed at a rate of two per
day in a “domino effect” (Galbraith, 1955: p.197). This crisis generated deflation, as it
convinced bankers to accumulate reserves and the public to hoard cash (Friedman
and Schwartz, 1964). This in turn reduced the supply of money, particularly the
amount of money in checking accounts, which at the time were the principal
means of payment for goods and services. As the stock of money declined, the
prices of goods inevitably followed.
Krugman (2013) takes a very similar approach to Keynes in regards to the causes
of the Great Depression, reiterating his point of inadequate economic
intelligence, which aided the creation of the poor banking structure. He recommended
more government spending (2013: xi), and the expansion of money supply by the
Federal Reserve System (Fed). This would have inspired consumer confidence, and
re-established the circular flow of money. He concludes, like Keynes, that
clear fiscal stimulus is the solution, but the area we need to focus on is
getting this point through to the people in power (2013: p108). Krugman is
effective in highlighting how poor economic intelligence was not only a
relevant cause in the 1930s, but also played a part in the subsequent financial



Natural cycle:


Alternatively, the
Great Depression could be considered the result of the natural cycle of the economy
after a boom. Hayek (1932) concurred with more traditional economists,
believing that the economy operates in an organic way and to intervene would be
disastrous in the long run. He disputes Keynes’s view by claiming that combating
the depression by a forced credit expansion is to “attempt to cure the evil by
the very means which brought it about” (Hayek, 1932: p.6). It should be fairly
clear that the granting of credit to consumers, which had recently been so
strongly advocated as a cure for depression, would in fact have quite the
contrary effect. Such ‘artificial demand’ would merely postpone the day of
reckoning. He suggested that the only permanent way to “mobilise” all available
resources is, therefore, not to use artificial stimulants but to “leave it to
time to effect a permanent cure” (Hayek, 1932: p.275). Furthermore, Hayek
believes that busts are simply the result of malinvestment in boom times, and
hence the Great Depression was part of the natural cycle of the economy.
Therefore, only to a certain extent was the collapse of the stock market
responsible for the Great Depression, perhaps it was inevitable after a time of
such prosperity.




Monetary contraction/FED

The monetary contraction and policies
by the Fed at the time is thought to have been another cause of the Great
Depression. Friedman and Schwartz (1963) claimed that the drastic decline in the
quantity of money caused by Fed from 1929 to 1933, and their failure to prevent
bank failings, was responsible for the severe depression. Friedman (1975)
observed that the Fed could have prevented the decline of one-third in the
quantity of money in this period. Had it done so, he states, the depression
would have been “far milder and briefer” (1975: p.328). Friedman and Schwartz (1963) think the Fed made crucial mistakes, as
it was preoccupied with stopping stock speculation and did not focus on the
effects that credit tightening would have on the real economy. Friedman (1990) claims that the Fed
could have provided a far better solution by engaging in large-scale open
market purchases of government bonds. That would have provided banks with
additional cash to meet the demands of their depositors, and therefore sharply
reduce the stream of bank failures. Unfortunately, he remarks, the Fed’s actions
were “hesitant and small” (Friedman, 1990: p.83). As
the lender of last resort, they were in a prime position to limit the fallout
by providing emergency funds to banks under distress. However, Fed policy at
that time dictated that only banks with sufficient collateral or member banks
of the System were eligible for these funds.
Consequently, destitute banks failed in large numbers. Friedman and Schwartz (1963) opposed
Galbraith’s theory, and concluded that the Great Depression was not the
necessary and direct result of the stock market crash, which they attribute to
a speculative investment bubble. In fact, they believed that the economy
could have recovered rather rapidly if only the Fed had not engaged in a series
of disastrous policies in the aftermath of the crash.
Therefore, while the Wall Street Crash may have initiated a depression, the
ineffectual response of the Federal Reserve transformed it into a Great



For many decades,
economists have found it difficult to determine the cause of the Great
Depression. Galbraith (1955: p.186) claims that none is more “intractable” than
assessing the responsibility of the stock market crash. However, upon
evaluation, while the crash appeared to have initiated the depression, there
were other pre-existing weaknesses of the economy that enhanced the effects of
the crash. Therefore, perhaps the economy could have recovered quicker if not
for factors, such as the lack of government intervention, which arguably
prolonged and exacerbated the depression.























“The Theory of
Moral Sentiments,” – invisible hand, Adam Smith

 The General Theory of Employment,
Interest and Money (1936)

Tract on Monetary Reform, in 1923 – “In the long run, we are all dead”

this Depression Now (2013) Krugman

‘A Monetary History of the
United States’ written in 1963′

‘The great myths of 1929
and the Lessons to be Learned’ – Harold Bierman. Jr. New York: Greenwood Press,
1991 p.xii +203

Prices & Production & Other works (1932) – F.A Hayek – 2008 –
Ludwig von Mises Institute, p.6

Keynes Hayek: The Clash that Defined Modern Economics – Nicholas
Wapshott – 2012








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Keynes, J.M.,
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