Causes Of The Great Depression


Causes Of The Great Depression Essay, Research Paper

The Great Depression was the worst economic slump ever in U.S.

history, and one which spread to virtually all of the industrialized

world. The depression began in late 1929 and lasted for about a

decade. Many factors played a role in bringing about the depression;

however, the main cause for the Great Depression was the combination

of the greatly unequal distribution of wealth throughout the 1920’s,

and the extensive stock market speculation that took place during the

latter part that same decade. The maldistribution of wealth in the

1920’s existed on many levels. Money was distributed disparately

between the rich and the middle-class, between industry and

agriculture within the United States, and between the U.S. and Europe.

This imbalance of wealth created an unstable economy. The excessive

speculation in the late 1920’s kept the stock market artificially

high, but eventually lead to large market crashes. These market

crashes, combined with the maldistribution of wealth, caused the

American economy to capsize.

The “roaring twenties” was an era when our country prospered

tremendously. The nation’s total realized income rose from $74.3

billion in 1923 to $89 billion in 1929(end note 1). However, the

rewards of the “Coolidge Prosperity” of the 1920’s were not shared

evenly among all Americans. According to a study done by the Brookings

Institute, in 1929 the top 0.1% of Americans had a combined income

equal to the bottom 42%(end note 2). That same top 0.1% of Americans

in 1929 controlled 34% of all savings, while 80% of Americans had no

savings at all(end note 3). Automotive industry mogul Henry Ford

provides a striking example of the unequal distribution of wealth

between the rich and the middle-class. Henry Ford reported a personal

income of $14 million(end note 4) in the same year that the average

personal income was $750(end note 5). By present day standards, where

the average yearly income in the U.S. is around $18,500(end note 6),

Mr. Ford would be earning over $345 million a year! This

maldistribution of income between the rich and the middle class grew

throughout the 1920’s. While the disposable income per capita rose 9%

from 1920 to 1929, those with income within the top 1% enjoyed a

stupendous 75% increase in per capita disposable income(end note 7).

A major reason for this large and growing gap between the rich

and the working-class people was the increased manufacturing output

throughout this period. From 1923-1929 the average output per worker

increased 32% in manufacturing(end note 8). During that same period of

time average wages for manufacturing jobs increased only 8%(end note

9). Thus wages increased at a rate one fourth as fast as productivity

increased. As production costs fell quickly, wages rose slowly, and

prices remained constant, the bulk benefit of the increased

productivity went into corporate profits. In fact, from 1923-1929

corporate profits rose 62% and dividends rose 65%(end note 10).

The federal government also contributed to the growing gap

between the rich and middle-class. Calvin Coolidge’s administration

(and the conservative-controlled government) favored business, and as

a result the wealthy who invested in these businesses. An example of

legislation to this purpose is the Revenue Act of 1926, signed by

President Coolidge on February 26, 1926, which reduced federal income

and inheritance taxes dramatically(end note 11). Andrew Mellon,

Coolidge’s Secretary of the Treasury, was the main force behind these

and other tax cuts throughout the 1920’s. In effect, he was able to

lower federal taxes such that a man with a million-dollar annual

income had his federal taxes reduced from $600,000 to $200,000(end

note 12). Even the Supreme Court played a role in expanding the gap

between the socioeconomic classes. In the 1923 case Adkins v.

Children’s Hospital, the Supreme Court ruled minimum-wage legislation

unconstitutional(end note 13).

The large and growing disparity of wealth between the well-to-do

and the middle-income citizens made the U.S. economy unstable. For an

economy to function properly, total demand must equal total supply. In

an economy with such disparate distribution of income it is not

assured that demand will always equal supply. Essentially what

happened in the 1920’s was that there was an oversupply of goods. It

was not that the surplus products of industrialized society were not

wanted, but rather that those whose needs were not satiated could not

afford more, whereas the wealthy were satiated by spending only a

small portion of their income. A 1932 article in Current History

articulates the problems of this maldistribution of wealth:

“We still pray to be given each day our daily bread. Yet there is too

much bread, too much wheat and corn, meat and oil and almost every

other commodity required by man for his subsistence and material

happiness. We are not able to purchase the abundance that modern

methods of agriculture, mining and manufacturing make available in

such bountiful quantities(end note 14).”

Three quarters of the U.S. population would spend essentially all of

their yearly incomes to purchase consumer goods such as food, clothes,

radios, and cars. These were the poor and middle class: families with

incomes around, or usually less than, $2,500 a year. The bottom three

quarters of the population had an aggregate income of less than 45% of

the combined national income; the top 25% of the population took in

more than 55% of the national income(end note 15). While the wealthy

too purchased consumer goods, a family earning $100,000 could not be

expected to eat 40 times more than a family that only earned $2,500

a year, or buy 40 cars, 40 radios, or 40 houses.

Through such a period of imbalance, the U.S. came to rely upon

two things in order for the economy to remain on an even keel: credit

sales, and luxury spending and investment from the rich.

One obvious solution to the problem of the vast majority of the

population not having enough money to satisfy all their needs was to

let those who wanted goods buy products on credit. The concept of

buying now and paying later caught on quickly. By the end of the

1920’s 60% of cars and 80% of radios were bought on installment

credit(end note 16). Between 1925 and 1929 the total amount of

outstanding installment credit more than doubled from $1.38 billion to

around $3 billion(end note 17). Installment credit allowed one to

“telescope the future into the present”, as the President’s Committee

on Social Trends noted(end note 18). This strategy created artificial

demand for products which people could not ordinarily afford. It put

off the day of reckoning, but it made the downfall worse when it came.

By telescoping the future into the present, when “the future” arrived,

there was little to buy that hadn’t already been bought. In addition,

people could not longer use their regular wages to purchase whatever

items they didn’t have yet, because so much of the wages went to

paying back past purchases.

The U.S. economy was also reliant upon luxury spending and

investment from the rich to stay afloat during the 1920’s. The

significant problem with this reliance was that luxury spending and

investment were based on the wealthy’s confidence in the U.S. economy.

If conditions were to take a downturn (as they did with the market

crashed in fall and winter 1929), this spending and investment would

slow to a halt. While savings and investment are important for an

economy to stay balanced, at excessive levels they are not good.

Greater investment usually means greater productivity. However, since

the rewards of the increased productivity were not being distributed

equally, the problems of income distribution (and of overproduction)

were only made worse. Lastly, the search for ever greater returns on

investment lead to wide-spread market speculation.

Maldistribution of wealth within our nation was not limited to

only socioeconomic classes, but to entire industries. In 1929 a mere

200 corporations controlled approximately half of all corporate

wealth(end note 19). While the automotive industry was thriving in the

1920’s, some industries, agriculture in particular, were declining

steadily. In 1921, the same year that Ford Motor Company reported

record assets of more than $345 million, farm prices plummeted, and

the price of food fell nearly 72% due to a huge surplus(end note 20).

While the average per capita income in 1929 was $750 a year for all

Americans, the average annual income for someone working in

agriculture was only $273(end note 21). The prosperity of the 1920’s

was simply not shared among industries evenly. In fact, most of the

industries that were prospering in the 1920’s were in some way linked

to the automotive industry or to the radio industry.

The automotive industry was the driving force behind many other

booming industries in the 1920’s. By 1928, with over 21 million cars

on the roads, there was roughly one car for every six Americans(end

note 22). The first industries to prosper were those that made

materials for cars. The booming steel industry sold roughly 15% of its

products to the automobile industry(end note 23). The nickel, lead,

and other metal industries capitalized similarly. The new closed cars

of the 1920’s benefited the glass, leather, and textile industries

greatly. And manufacturers of the rubber tires that these cars used

grew even faster than the automobile industry itself, for each car

would probably need more than one set of tires over the course of its

life. The fuel industry also profited and expanded. Companies such as

Ethyl Corporation made millions with items such as new “knock-free”

fuel additives for cars(end note 24). In addition, “tourist homes”

(hotels and motels) opened up everywhere. With such a wealthy

upper-class many luxury hotels were needed. In 1924 alone, hotels such

as the Mayflower (Washington D.C.), the Parker House (Boston), The

Palmer House (Chicago), and the Peabody (Memphis) opened their

doors(end note 25). Lastly, and possibly most importantly, the

construction industry benefited tremendously from the automobile. With

the growing number of cars, there was a big demand for paved roads.

During the 1920’s Americans spent more than a $1 billion each year on

the construction and maintenance of highways, and at least another

$400 million annually for city streets(end note 26). But the

automotive industry affected construction far more than that. The

automobile had been central to the urbanization of the country in the

1920’s because so many other industries relied upon it. With

urbanization came the need to build many more apartment buildings,

factories, offices, and stores. From 1919 to 1928 the construction

industry grew by around $5 billion dollars, nearly 50%(end note 27).

Also prospering during the 1920’s were businesses dependent upon

the radio business. Radio stations, electronic stores, and electricity

companies all needed the radio to survive, and relied upon the

constant growth of the radio market to expand and grow themselves. By

1930, 40% of American families had radios(end note 28). In 1926 major

broadcasting companies started appearing, such as the National

Broadcasting Company. The advertising industry was also becoming

heavily reliant upon the radio both as a product to be advertised, and

as a method of advertising.

Several factors lead to the concentration of wealth and

prosperity into the automotive and radio industries. First, during

World War I both the automobile and the radio were significantly

improved upon. Both had existed before, but radio had been mostly

experimental. Due to the demands of the war, by 1920 automobiles,

radios, and the parts necessary to build these things were being

produced in large quantities; the work force in these industries had

been formed and had become experienced. Manufacturing plants were

already in place. The infrastructure existed for the automotive and

radio industries to take off. Second, due to federal government’s

easing of credit, money was available to invest in these industries.

Thanks to pressure from President Coolidge and the business world, the

Federal Reserve Board kept the rediscount rate low.

The federal government favored the new industries as opposed to

agriculture. During World War I the federal government had subsidized

farms, and payed absurdly high prices for wheat and other grains. The

federal government had encouraged farmers to buy more land, to

modernize their methods with the latest in farm technology, and to

produce more food. This made sense during that war when war-ravaged

Europe had to be fed too. However as soon as the war ended, the U.S.

abruptly stopped its policies to help farmers. During the war the

United States government had paid an unheard of $2 a bushel for wheat,

but by 1920 wheat prices had fallen to as low as 67 cents a bushel(end

note 29). Farmers fell into debt; farm prices and food prices tumbled.

Although modest attempts to help farmers were made in 1923 with the

Agricultural Credits Act, farmers were generally left out in the cold

by the government.

The problem with such heavy concentrations of wealth and such

massive dependence upon essentially two industries is similar to the

problem with few people having too much wealth. The economy is reliant

upon those industries to expand and grow and invest in order to

prosper. If those two industries, the automotive and radio industries,

were to slow down or stop, so would the entire economy. While the

economy did prosper greatly in the 1920’s, because this prosperity

wasn’t balanced between different industries, when those industries

that had all the wealth concentrated in them slowed down, the whole

economy did. The fundamental problem with the automobile and radio

industries was that they could not expand ad infinitum for the simple

reason that people could and would buy only so many cars and radios.

When the automotive and radio industries went down all their

dependents, essentially all of American industry, fell. Because it had

been ignored, agriculture, which was still a fairly large segment of

the economy, was already in ruin when American industry fell.

A last major instability of the American economy had to do with

large-scale international wealth distribution problems. While America

was prospering in the 1920’s, European nations were struggling to

rebuild themselves after the damage of war. During World War I the

U.S. government lent its European allies $7 billion, and then another

$3.3 billion by 1920(end note 30). By the Dawes Plan of 1924 the U.S.

started lending to Axis Germany. American foreign lending continued in

the 1920’s climbing to $900 million in 1924, and $1.25 billion in 1927

and 1928(end note 31). Of these funds, more than 90% were used by the

European allies to purchase U.S. goods(end note 32). The nations the

U.S. had lent money to (Britain, Italy, France, Belgium, Russia,

Yugoslavia, Estonia, Poland, and others) were in no position to

pay off the debts. Their gold had flowed into the U.S. during and

immediately after the war in great quantity; they couldn’t send more

gold without completely ruining their currencies. Historian John D.

Hicks describes the Allied attitude towards U.S. loan repayment:

“In their view the war was fought for a common objective, and the

victory was as essential for the safety of the United States as for

their own. The United States had entered the struggle late, and had

poured forth no such contribution in lives and losses as the Allies

had made. It had paid in dollars, not in death and destruction, and

now it wanted its dollars back(end note 33).”

There were several causes to this awkward distribution of wealth

between U.S. and its European counterparts. Most obvious is that fact

that World War I had devastated European business. Factories, homes,

and farms had been destroyed in the war. It would take time and money

to recuperate. Equally important to causing the disparate distribution

of wealth was tariff policy of the United States. The United States

had traditionally placed tariffs on imports from foreign countries in

order to protect American business. However these tariffs reached an

all-time high in the 1920’s and early 1930’s. Starting with the

Fordney-McCumber Act of 1922 and ending with the Hawley-Smoot Tariff

of 1930, the United States increased many tariffs by 100% or more(end

note 34). The effect of these tariffs was that Europeans were unable

to sell their own goods in the United States in reasonable quantities.

In the 1920’s the United States was trying “to be the world’s

banker, food producer, and manufacturer, but to buy as little as

possible from the world in return.”(end note 35) This attempt to have

a constantly favorable trade balance could not succeed for long. The

United States maintained high trade barriers so as to protect American

business, but if the United States would not buy from our European

counterparts, then there was no way for them to buy from the

Americans, or even to pay interest on U.S. loans. The weakness of the

international economy certainly contributed to the Great Depression.

Europe was reliant upon U.S. loans to buy U.S. goods, and the U.S.

needed Europe to buy these goods to prosper. By 1929 10% of American

gross national product went into exports(end note 36). When the

foreign countries became no longer able to buy U.S. goods, U.S.

exports fell 30% immediately. That $1.5 billion of foreign sales lost

between 1929 to 1933 was fully one eighth of all lost American sales

in the early years of the depression(end note 37).

Mass speculation went on throughout the late 1920’s. In 1929

alone, a record volume of 1,124,800,410 shares were traded on the New

York Stock Exchange(end note 38). From early 1928 to September 1929

the Dow Jones Industrial Average rose from 191 to 381(end note 39).

This sort of profit was irresistible to investors. Company earnings

became of little interest; as long as stock prices continued to rise

huge profits could be made. One such example is RCA corporation, whose

stock price leapt from 85 to 420 during 1928, even though it had not

yet paid a single dividend(end note 40). Even these returns of over

100% were no measure of the possibility for investors of the time.

Through the miracle of buying stocks on margin, one could buy stocks

without the money to purchase them. Buying stocks on margin functioned

much the same way as buying a car on credit. Using the example of RCA,

a Mr. John Doe could buy 1 share of the company by putting up $10 of

his own, and borrowing $75 from his broker. If he sold the stock at

$420 a year later he would have turned his original investment of

just $10 into $341.25 ($420 minus the $75 and 5% interest owed to the

broker). That makes a return of over 3400%! Investors’ craze over the

proposition of profits like this drove the market to absurdly high

levels. By mid 1929 the total of outstanding brokers’ loans was over

$7 billion(end note 41); in the next three months that number would

reach $8.5 billion(end note 42). Interest rates for brokers loans were

reaching the sky, going as high as 20% in March 1929(end note 43). The

speculative boom in the stock market was based upon confidence. In the

same way, the huge market crashes of 1929 were based on fear.

Prices had been drifting downward since September 3, but

generally people where optimistic. Speculators continued to flock to

the market. Then, on Monday October 21 prices started to fall quickly.

The volume was so great that the ticker fell behind(end note 44).

Investors became fearful. Knowing that prices were falling, but not by

how much, they started selling quickly. This caused the collapse to

happen faster. Prices stabilized a little on Tuesday and Wednesday,

but then on Black Thursday, October 24, everything fell apart again.

By this time most major investors had lost confidence in the market.

Once enough investors had decided the boom was over, it was over.

Partial recovery was achieved on Friday and Saturday when a group of

leading bankers stepped in to try to stop the crash. But then on

Monday the 28th prices started dropping again. By the end of the day

the market had fallen 13%(end note 45). The next day, Black Tuesday an

unprecedented 16.4 million shares changed hands(end note 46). Stocks

fell so much, that at many times during the day no buyers were

available at any price(end note 47).

This speculation and the resulting stock market crashes acted as

a trigger to the already unstable U.S. economy. Due to the

maldistribution of wealth, the economy of the 1920’s was one very much

dependent upon confidence. The market crashes undermined this

confidence. The rich stopped spending on luxury items, and slowed

investments. The middle-class and poor stopped buying things with

installment credit for fear of loosing their jobs, and not being able

to pay the interest. As a result industrial production fell by more

than 9% between the market crashes in October and December 1929(end

note 48). As a result jobs were lost, and soon people starting

defaulting on their interest payment. Radios and cars bought with

installment credit had to be returned. All of the sudden warehouses

were piling up with inventory. The thriving industries that had been

connected with the automobile and radio industries started falling

apart. Without a car people did not need fuel or tires; without a

radio people had less need for electricity. On the international

scene, the rich had practically stopped lending money to foreign

countries. With such tremendous profits to be made in the stock market

nobody wanted to make low interest loans. To protect the nation’s

businesses the U.S. imposed higher trade barriers (Hawley-Smoot Tariff

of 1930). Foreigners stopped buying American products. More jobs were

lost, more stores were closed, more banks went under, and more

factories closed. Unemployment grew to five million in 1930, and up to

thirteen million in 1932(end note 49). The country spiraled quickly

into catastrophe. The Great Depression had begun.

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