Causes of
the Great Depression &
Hoover’s Response
Myths and Misconceptions
• Many people believe that the crash of the stock market was the
cause of the Depression. Not so, it was only a symptom.
• Many people also believe that Herbert Hoover’s laissez-fair
economic philosophy prevented the federal government from taking
steps to prevent the crisis. Hoover was proactive in trying to ease the
impact of the depression, it was too little, too late.
• Many people think that the Great Depression was the only major
economic crisis in U.S. history. Nope, but it was the worst.
• Many people do not realize that the Depression was global and
affected almost every capitalist economy on earth
• Some believe that FDR and the New Deal ended the Depression.
Wrong again, WWII ended he Depression
The Facts
• In September of 1929 the U.S. economy began showing signs of
contraction (decline from the growth of the 1920’s)
• August 1929, recession begins, GDP falls by and unemployment
rises.
• Automobile sales fall 30% in 1929.
• By 1929 farm incomes fall more than 50%
• September 1929 stock prices begin to fall, the market crash on
Black Tuesday October 29th losing 90% of its value by 1932.
• By 1932 US GDP fell 30%
• 1929-1932 US factory production fell 46%
• 1929-1932 US wholesale prices fell 32%
• 1929-1932 US exports fell 70%
• 1929-1932 US unemployment will reach 25% (33% in some regions)
US Unemployment 1910-1960
Abstract of the US Department of Labor
US GDP 1910-1960
Based on data from: Louis D. Johnston and Samuel H. Williamson, "What Was the U.S. GDP
US Farm Prices 1928-1932
US Bureau of Labor Statistics
US Industrial Production
US Stock Market 1928-1932
US Bureau of Labor Statistics
Many did not realize how severe the downturn
was until 1932, when the economy had
technically “hit bottom.”
Brother Can You Spare a Dime?
Once I built a railroad, I made it run
I made it race against time
Once I built a railroad, now it's done
Brother, can you spare a dime?
Once I built a tower, up to the sun
Bricks and mortar and lime
Once I built a tower, now it's done
Brother, can you spare a dime?
Overproduction
Banking Practices
& Fed Policies
Causes of the Great Depression
Stock Market
Political Decisions
1. Over-production
Overproduction
• The “roaring twenties” was an era of great prosperity and
economic growth.
• Average output per worker increased 32% in manufacturing
and corporate profits rose 62%.
• The availability of so many consumer goods, such as electric
appliances, radios and automobiles, offered to make life
easier.
• Americans felt they deserved to reward themselves after the
sacrifices of World War I. A return to normalcy.
• This led to a high demand for such goods,
so companies began to produce more and more, in order to
meet that demand.
Overproduction
• Mass advertising fed mass consumption to satisfy the needs of mass
production.
• Wages for labor remained stagnant (mechanization of labor, Taylorism,
suppression of union collective bargaining). Businesses were investing
profits in the stock market and not in workers wages. So….
• The uneven distribution of wealth grows. 1922 1% of the population
owns 36.7% of the nations wealth by 1929 it has grown to 44.2%
• Eventually business produced more than consumers could purchase.
You can only own so many radios, cars, and appliances.
• August 1929 Recession begins, two months before the stock market
crash. During this two month period, production fell 20%, wholesale
prices at 7.5 %, and personal income fell 5%.
Farm Overproduction
• In 1929, Agriculture still makes up half of the US economy
• During World War I, with European farms in ruin, the
American farm was a prosperous business.
• Increased food production during World War I was an
economic “boom” for many farmers, who borrowed money to
enlarge and modernize their farms.
• The government had also subsidized farms during the war,
paying high prices for wheat and grains.
• When the subsidies were cut, it became difficult for many
farmers to pay their debts when commodity prices dropped
to normal levels.
So…
• Over production of consumer goods and
agricultural goods means…
• Supply was greater than demand.
• A surplus of goods in the market begins
to drive prices down.
• Declining prices means declining profits
• Declining profits means stock values (for
corporations) begin to fall.
• Oh my!!!
2. Banking & Money Policies
Consumer Credit
• The uneven distribution of
wealth didn’t stop the poor
and middle class from
wanting to possess luxury
items, such as
cars and radios…
• But, wages were not
keeping up with the prices
…and that created
problems!
Consumer Credit
• One solution was to let products be purchased on credit.
• The concept of “buying now and paying later”
caught on quickly.
• By the end of the 1920s, 60% of the cars and 80% of the
radios were bought on installment credit.
• Consumerism in the New Era saw a change in US buying
behavior. Thrift, saving, and frugality were replaced with
consumption, and keeping up with the Jones’
The Federal Reserve Board
• The Federal Reserve Board was created by Congress in 1917 in
response to the Banking Crisis of 1907.
• The Fed was created as the US central bank with two primary
functions:
– 1) Regulate and inspect the nations commercial banks,
by assuring banks had sufficient cash reserves
– 2) Regulate the amount of money circulating in the
economy. Known as Monetary Policy
• To stimulate growth the Fed increases money in circulation by
lowering interest rates for member banks, and decrease in the
amount of money banks are required to keep in reserve
Fed Monetary Policy
• The Federal Reserve was suppose to serve as a
protective “watchdog” of the nation’s economy.
• It had the power to set the interest rate for loans
issued by banks.
• In the 1920’s, the Fed encouraged buying on credit by
lowering interest rates (discount rate)
• Eventually so many people were buying on credit that
inflation increased.
So…
• By 1929 the Fed decided to slow the rapid (runaway?) growth
by increasing interest rates.
• Raising interest rates means that it cost more to borrow and
raises the price of existing debt.
• So. People borrowed less and purchased fewer goods.
• They also started using available cash to pay off debt and
therefore purchased fewer goods.
• Less demand = surplus goods = deflation = declining profits =
declining stock prices = rising unemployment
• Oh my!
3. STOCK MARKET ACTIONS
The Stock Market
• The Stock Market is seen as an indicator of the nation’s
economy.
• In reality it is only and index of the value of corporate stocks
based primarily on the market demand for a particular stock
• As an investment the goal is to buy low and sell high.
• The value of stocks soared in the 1920’s as corporate profits
rose, fueled by mass consumption. (Fueled by credit,
shhhhhh!!!)
• Once a rich man’s game, everyone was “in the market” in
the 20’s
• Optimism was high, and speculation was rampant
Stock Market: Buying on Margin
• Buying on the margin means that you can purchase shares
with a don payment.
• The Margin Requirement in 1926 was 10%. So a $100 share
of stock could be yours with only a $10 down payment
• Speculators expect the value of the stock to go up in price
enough (at least 90% to break even) covering the balance.
• Buying on the margin encouraged thousands of small time,
new (inexperienced) investors to purchase stocks
• As long as corporations were selling goods and turning a
profit stock prices rose and buying on the margin was safe.
• As long as…
George Olsen
"I'm In The Market For You”
I'll have to see my broker
Find out what he can do.
'Cause I'm in the market for you.
With margin I'm all through.
'Cause I want you outright it's true.
We'll count the hugs and kisses,
When dividends are due,
'Cause I'm in the market for you.
Stock Market: Banks & Margins
• In 1927 banks did two stupid, greedy things
–1) Banks began letting customers borrow money to buy
stocks and used the customers stock holdings as
collateral for the loan.
They gave money to people with no money to gamble
–2) Banks started to use depositors money to speculate in the
stock market. Normally banks pay you interest for savings.
Then they loan it to businesses or families that were good
risks to buy homes or start companies etc.
Not speculate in the market!
• By 1929, banks had made billions of dollars in risky loans with
little collateral to back them up if borrowers defaulted.
So what went wrong?
Stock Market Crash
• Black Tuesday, October 29th 1929.
• The market bubble bursts with a panic sell off of 16 million shares of
stock.
• Investors lose 26 billion dollars (312 billion in 2010 dollars)
• The crash was not a one day event, stocks falling in September.
Wealthy investors stepped in a bought up shares at bargain prices.
• Those who bought on margin, however, panicked.
• It is impossible to know exactly what caused the initial panic but the
market crash exposed the other problems in the economy setting into
motion a deep lack of confidence in the economy.
So…
• Banks made risky loans to borrowers to
buy stocks on the margin.
• Banks used depositors money to
speculate in the market
• When panic shook the market, the banks
were left holding the bag
• Oh my…
4. Bad Fed Banking Policies
• With the loss of confidence in stocks, people began to lose
confidence in the security of their money being held in
banks.
• Customers raced to their banks to withdraw their savings.
(k.a. bank run)
• Customers closed accounts and banks were left without
cash reserves putting them on the brink of failure.
4. Bad Fed Banking Policies
• In its regulatory role, the Federal Reserve was also
established to prevent bank closings.
• It was suppose to serve as the lender of last resort to banks
on the verge of collapsing.
However,
• The Fed lowered the reserve requirement for banks, so the
banks did not have the cash to cover customer withdrawals.
And the Fed did not provide short term loans to banks to
cover the loses.
• 1930 the Fed cuts interest rates from 6% to 4% in attempt to
increase the money supply
So…
• Banks started to close, increasing the panic.
• 1930, 60 banks fail every month, by 1933 over 9,000 banks
fail (40% of the 1929 total)
So…
• The Fed fails to manage the bank and
currency crisis.
• Depositors now hide their money at
home and banks have no money to lend
• Banks close and large amounts of
money disappear from the economy
So…
• Less money = less consumption = less
production
• Businesses go bankrupt
• People get laid off
• Thus the economy begins an irreversible
downward spiral.
• Banks close and large amounts of money
disappear from the economy
• By 1931, GNP falls by 18%, unemployment
reaches 16%(8 million)
4. Bad Political Decisions:
Political Decisions
• The severity of the Depression could have been lessened if
policy makers would have been open to new ideas
• Conservative economic policy
– Laissez fair, let the market right itself without government
intervention
– Balance the budget, do not spend more than collected in tax
revenue
• Prevailing belief that private charities, churches, state and
local governments provide relief and assistance to the poor,
not the Federal Government
– Most of these were ill equipped to deal with the number of
people in need
“The sole function of the
government is to bring about a
condition of affairs favorable to
the beneficial development of
private enterprise.”
~Herbert Hoover (1930)
“The Fed will stand by as the
market works itself out:
Liquidate labor, liquidate
stocks, liquidate real estate…
values will be adjusted, and
enterprising people will pick up
the wreck from less-competent
people."
~ Andrew Mellon (1930)
Hoover’s Political Decisions
• Contrary to popular history
Hoover’ commitment to laissez
fair made the Depression worse
• Hoover initiated several
programs to help the economy
recover but it was too little, too
late
• Hoover favored volunteerism, or
cooperation between business
and government over coercive
policy
Hoover’s Political Decisions
• Hoover promoted volunteerism.
Cooperation between
government and business
instead of coercive policies.
• He showed some pro-labor
policies:
– Asked business leaders to hold
wages steady even though
profits were falling
– Authorized repatriation for
50,000 Mexicans (and
Mexican-Americans) to ease
unemployment and cut the
relief rolls in California
Hoover’s Political Decisions
• Hoover promoted volunteerism to prop up failing banks.
• National Credit Corporation / Reconstruction Finance
Corporation (RFC)
• 1931, Hoover urged the larger (East Coast) banks to provide
low interest loans to struggling rural banks
• Large banks were unwilling to offer loans without holding the
smaller banks most valuable collateral.
• RFC failed to help the smaller banks.
Hoover’s Political Decisions
• Rising unemployment led to
homeowners defaulting on
mortgages and renters being
evicted from apartments.
• The homeless settled in shanty
towns called Hoovervilles
• 1932, Federal Home Loan
Bank Act, was passed to spur
new home construction, and
reduce foreclosures.
• Foreclosures dropped briefly in
late 1932.
Hoover’s Political Decisions
• The Revenue Act of 1932 reversed the Mellon tax cuts.
Increase taxes on struggling corporations and the wealthy =
more money in the federal treasury to fund aid without deficit
spending (more on this later)
• Emergency Relief and Construction Act of 1932. federal
money funneled to states to start public works projects
(roads, drainage, schools) to put people back to work
– Problem, it is not that easy to spend large amounts of money
quickly on shovel-ready projects
– Federal money trickled into states as the problem of
unemployment grew exponentially
Hoover’s Three Biggest Mistakes
• Signing the Smoot-Hawley Tariff
• Revenue Act of 1932
• Balancing the budget
Hoover & Smoot-Hawley
• The Smoot-Hawley Tariff was signed (reluctantly) by Hoover
in 1932
• It came on top of the Fordney-McCumber Tariff of 1922,
which had already put American agriculture into a tailspin.
• Smoot-Hawley raised tariffs by 50%
• Congress believed the tariff would make imports too
expensive and Americans would buy American goods,
increasing demand
• European countries retaliated with their own tariffs and U.S.
exports fell by almost 70%
Hoover & Smoot-Hawley
• The trade war cost American farmers 1/3 of their market
causing agricultural prices to fall and putting more farmers
into bankruptcy.
• Tariffs damaged an already shaky economy in Germany.
• Germany begins to default on reparations payments to
England and France required by the Versailles Treaty
– France and England fall behind in their payments on loans
from U.S. banks (used to buy weapons during WWI)
– Weakening large U.S. banks
Revenue Act of 1932 &
Balancing the Budget
• Concern over growing deficits Congress passes and Hoover signs
the Revenue Act of 1932
• The act reversed Mellon’s tax cuts.
– Raising business taxes from 12% to 13.75%
– Raised taxes on every bracket
– Lower income brackets increases form 1% to 4%
– Raised taxes on the wealthy from 24% to 64%
• The problem with raising taxes is that it takes money out of the
economy.
• Business facing lower profits had to now pay more taxes. To cut
cost they laid off workers
• Since nothing seemed to help the economy, Hoover and Congress
decided to balance the Federal budget.
– Cut spending (ex. veteran’s benefits)
• This shrunk the money supply even more
So…
• Hoover was not the laissez-fairie
• He supported government actions to
ease the crisis
But
• It was not enough
And
• He fell back on conservative economic
policy and tried to balance the budget
• Smoot-Hawley
• Ohhh….!!!
Let’s Review
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Overproduction
Stagnant wages
Federal monetary policy
Banking practices Stock market
Political decisions
FDR TO THE RESCUE