The Great Depression was undoubtedly the mostsevere economic downturn in the United States that lasted, with varyingseverity, for ten years. It can be viewed that the collapse of the stock marketin 1929 was the predominant cause of the depression.
However, there are otherweaknesses attributed to the cause of this event, for example the inequitable distributionof income, poor corporate structure, the inadequacy of economic intelligence,weak banking structure, the natural cycle of the economy and monetarycontraction by the Federal Reserve System. In what follows, each of these areaswill be discussed together with their relative responsibility for the GreatDepression. Finally, it will be argued that while the stock market collapse wasa contributory factor, other pre-existing weaknesses had a larger bearing onthe ensuing disaster. YES – The collapse of the stock market in October1929, otherwise known as the Wall Street Crash, is thought to be one of themain causes of the Great Depression. Throughout the beginning of the 1920s,employment and production were rapidly increasing; it was a “good time to be inbusiness” (Galbraith, 1954: p.31). Thiseconomic growth created speculation in stocks, as many anticipated continually risingshare prices. This enabled companies to acquire money at low price andtherefore invest in their own production.
However, this lead to overproduction in many areas and companies wereforced to dispose of their products at a loss, thus share prices began to fallin September 1929. Despite the declining price, speculation continued and onOctober 18th, the market spiralled downwards in a rush to sellstocks. The crash itself occurred on October 29th,the Dow had decreased by twenty-five percent from October 25th and investorslost over thirty billion dollars. Contraryto what had been Wall Street’s perceived tendency in deemphasising its role,Galbraith (1954) asserted the significance of the stock market crash on theGreat Depression. The crash spread uncertainty, where hopes of a prosperousfuture once prevailed, creating a sense of “utter hopelessness” (Galbraith,1954: p.
204). The destruction of confidence inhibited spending and thereforereduced demand and production levels. Furthermore, the plummeting value ofstocks forced many companies into bankruptcy, which led to increasingunemployment. The crash also ruined the normal method of investment andlending, which hindered economic growth and caused financial hardship that alienatedmany from the economic system, thus entrenching the United States in the GreatDepression. Therefore, to a certain extent, it can be shown that the collapseof the stock market was responsible for the Great Depression. NO – On the contrary, it can be viewed that theWall Street Crash was not the predominant cause of the Great Depression; ratherthere were pre-existing weaknesses in the economy that acted as moresignificant contributory factors. Bad distribution of incomeIn 1929, there was a vastly inequitabledistribution of income, which exacerbated the effects of the Wall Street Crashand therefore contributed to the Great Depression. At the time of the crash,the wealthy represented a vital proportion of the total population.
Although output perworker rose steadily during the period, wages and prices were relativelystable. As a result, business profits increased rapidly, as did the incomes ofthe wealthy. This suggests that the economy was heavily and increasinglydependent on the luxury consumption of the well-to-do and their willingness toreinvest what they did not spend on themselves.Galbraith (1954: p.203) described them as the source of a “lion’s share” ofpersonal saving and investment. The Wall Street Crash signified a collapse insecurity values, which first affected the affluent. Therefore, the shock to theirconfidence resulted in broad, severe effects on expenditure and income in theeconomy at large (Galbraith, 1954: p.
203). If wealth had been distributed moreevenly, the average person would have been able to spend more and therefore thedemand for goods and services would not have declined so severely. Thus, due tothe unequal distribution of income, the effect of the Wall Street Crash wasgreatly magnified and therefore acted as an important contributory factortowards the Great Depression.
Bad corporate structure The effects of the stock market crash wereworsened by the weaknesses in corporate structure, which further contributed tothe cause of the Great Depression. The most important corporate weakness wasinherent 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 mostcommon was the organisation of corporations to hold stock in yet morecorporations, which in turn held stock in further corporations.
Inthe case of the railroads and the utilities, the purpose of this pyramid wasthat dividends from the operating companies paid the interest on the bonds ofupstream holding companies. Here, Galbraith (1954:p.196) claimed was the “constant danger of devastation” by reverse leverage. Hestates 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 BlackThursday (put date) due to the vulnerability of its corporate structure.Furthermore, in many cases, the great investmenttrusts were organised to hold securities in other organisations in order tomanufacture more securities to sell to the public.
During 1929, one investmenthouse, Goldman, Sachs & Company, organised and sold approximately a billiondollars’ worth of securities in three interconnected investment trusts -Goldman Sachs Trading Corporation; Shenandoah Corporation; and Blue RidgeCorporation. All eventually depreciated to nothing during and after the crash. Galbraith(1954: p.1960) remarked that it would be hard to imagine a corporate systembetter designed to “accentuate a deflationary spiral.
” Therefore, the poorcorporate structure at the time of the Wall Street Crash prompted many majorcompanies to retrench, which increased unemployment and thus contributed to thecause of the Great Depression. Inadequacyof economic intelligence/bad banking structure/gov’s inability to respond tolack of demand (Keynes & Krugman)Another factor that begot the GreatDepression was the inadequacy of economic intelligence. Classical economists,such as Adam Smith (1759) believed that an ‘invisible hand’ guides the marketto regulate itself by means of competition, supply and demand, andself-interest. If competition is allowed, the economy will automaticallygravitate towards full employment. However, Keynes (1939) challenged this viewand claimed that the economy is not always at full employment; it could riseabove or below full potential for a long time.
During the Great Depression, consumption fell due to higherrates of savings and thus the rate of interest also declined. According to theclassical economists, lower interest rates would lead to increased investmentand aggregate demand would remain constant. However, Keynes (1936) argued that investmentdoes not necessarily increase in response to a fall in the interest rate. Forexample, if a fall in consumption appears to be long-term, as with the GreatDepression, then businesses will lower expectations of future sales. Therefore,it would have been preferable to decrease investment in future production andhence the economy is thrown into a slump. Keynes denied the self-correctingmechanism and concluded that government intervention was necessary to end theDepression. Hiswell-known phrase, “In the long run, we are all dead,” (1923: p.
80) signifies thatthe government should overcome issues in the short run, rather than wait for marketforces to resolve the economy in the long run. Furthermore, Keynes implied thatincreased government spending would ‘prime the pump’ of the economy byincreasing aggregate demand and thus proliferating economic activity, whichwould in turn reduce unemployment and alleviate the Great Depression.Therefore, due to the government’s inability to respond to the lack of demandat the time, the depression was aggravated and prolonged, and hence representeda significant cause of the Great Depression. Furthersupported by Krugman/bad banking structureFurthermore, Krugman(2013), as did Galbraith (1955), noted that the inherently weak banking structurealso played a role in causing the Great Depression.
Atthe start of the 1920s, new banks were opening at the rate of four to five perday, leading to a large number of independent units. However, there were fewfederal restrictions to determine how much start-up capital a bank needed orhow much of its reserves it could lend. As a result, most of these banks werehighly insolvent, and between 1923 and 1929, banks closed at a rate of two perday in a “domino effect” (Galbraith, 1955: p.197). This crisis generated deflation, as itconvinced bankers to accumulate reserves and the public to hoard cash (Friedmanand Schwartz, 1964). This in turn reduced the supply of money, particularly theamount of money in checking accounts, which at the time were the principalmeans of payment for goods and services. As the stock of money declined, theprices of goods inevitably followed.Krugman (2013) takes a very similar approach to Keynes in regards to the causesof the Great Depression, reiterating his point of inadequate economicintelligence, which aided the creation of the poor banking structure.
He recommendedmore government spending (2013: xi), and the expansion of money supply by theFederal Reserve System (Fed). This would have inspired consumer confidence, andre-established the circular flow of money. He concludes, like Keynes, thatclear fiscal stimulus is the solution, but the area we need to focus on isgetting this point through to the people in power (2013: p108). Krugman iseffective in highlighting how poor economic intelligence was not only arelevant cause in the 1930s, but also played a part in the subsequent financialdisaster. Natural cycle:Hayek Alternatively, theGreat Depression could be considered the result of the natural cycle of the economyafter a boom.
Hayek (1932) concurred with more traditional economists,believing that the economy operates in an organic way and to intervene would bedisastrous in the long run. He disputes Keynes’s view by claiming that combatingthe depression by a forced credit expansion is to “attempt to cure the evil bythe very means which brought it about” (Hayek, 1932: p.6). It should be fairlyclear that the granting of credit to consumers, which had recently been sostrongly advocated as a cure for depression, would in fact have quite thecontrary effect. Such ‘artificial demand’ would merely postpone the day ofreckoning. He suggested that the only permanent way to “mobilise” all availableresources is, therefore, not to use artificial stimulants but to “leave it totime to effect a permanent cure” (Hayek, 1932: p.275).
Furthermore, Hayekbelieves that busts are simply the result of malinvestment in boom times, andhence the Great Depression was part of the natural cycle of the economy.Therefore, only to a certain extent was the collapse of the stock marketresponsible for the Great Depression, perhaps it was inevitable after a time ofsuch prosperity. Monetary contraction/FEDThe monetary contraction and policiesby the Fed at the time is thought to have been another cause of the GreatDepression. Friedman and Schwartz (1963) claimed that the drastic decline in thequantity of money caused by Fed from 1929 to 1933, and their failure to preventbank failings, was responsible for the severe depression. Friedman (1975)observed that the Fed could have prevented the decline of one-third in thequantity of money in this period. Had it done so, he states, the depressionwould have been “far milder and briefer” (1975: p.328). Friedman and Schwartz (1963) think the Fed made crucial mistakes, asit was preoccupied with stopping stock speculation and did not focus on theeffects that credit tightening would have on the real economy.
Friedman (1990) claims that the Fedcould have provided a far better solution by engaging in large-scale openmarket purchases of government bonds. That would have provided banks withadditional cash to meet the demands of their depositors, and therefore sharplyreduce the stream of bank failures. Unfortunately, he remarks, the Fed’s actionswere “hesitant and small” (Friedman, 1990: p.83). Asthe lender of last resort, they were in a prime position to limit the falloutby providing emergency funds to banks under distress.
However, Fed policy atthat time dictated that only banks with sufficient collateral or member banksof the System were eligible for these funds.Consequently, destitute banks failed in large numbers. Friedman and Schwartz (1963) opposedGalbraith’s theory, and concluded that the Great Depression was not thenecessary and direct result of the stock market crash, which they attribute toa speculative investment bubble.
In fact, they believed that the economycould have recovered rather rapidly if only the Fed had not engaged in a seriesof disastrous policies in the aftermath of the crash.Therefore, while the Wall Street Crash may have initiated a depression, theineffectual response of the Federal Reserve transformed it into a GreatDepression. ConclusionFor many decades,economists have found it difficult to determine the cause of the GreatDepression. Galbraith (1955: p.186) claims that none is more “intractable” thanassessing the responsibility of the stock market crash.
However, uponevaluation, while the crash appeared to have initiated the depression, therewere other pre-existing weaknesses of the economy that enhanced the effects ofthe crash. Therefore, perhaps the economy could have recovered quicker if notfor factors, such as the lack of government intervention, which arguablyprolonged and exacerbated the depression. Bibliography “The Theory ofMoral Sentiments,” – invisible hand, Adam Smith The General Theory of Employment,Interest and Money (1936)TheTract on Monetary Reform, in 1923 – “In the long run, we are all dead”Endthis Depression Now (2013) Krugman’A Monetary History of theUnited States’ written in 1963”The great myths of 1929and the Lessons to be Learned’ – Harold Bierman. Jr. New York: Greenwood Press,1991 p.xii +203Prices & Production & Other works (1932) – F.A Hayek – 2008 –Ludwig von Mises Institute, p.6Keynes Hayek: The Clash that Defined Modern Economics – NicholasWapshott – 2012 1.
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