The Great Depression and Economic Theory
How did the Stock Market Crash of 1929 effect worldwide trade
relations? According to Economic Theory, what caused the economy
collapse of 1929?
(Include both United States as well as European countries in your
discussion).
It was appropriate that the terrible economic slump of the 1930s started in
the United States, to which Europe seemed to have surrendered economic
leadership during the Great War and on which she had been dependent ever
since.
Stock Market Crash
The stock market crash that began on a black Friday in October 1929 and
deepened in the ensuing months had immediate repercussion in Europe.
Indeed, even before this, the superheated boom in stock prices that marked
the bull market of 1928 siphoned money from Europe. The pricking of the
bubble sent shock waves throughout the world.
Large exports of American capital had helped sustain Europe, besides
providing an outlet for American surpluses of capital, during the 1920s.
Investment in European bonds now contracted sharply and swiftly, as banks
that were "caught short" with too many of their assets invested in securities
desperately tried to raise money. By June 1930, the price of securities on
Wall Street was about 20 percent, on average, of what it had been prior to
the crash; between 1929 and 1932 the Dow-Jones average of industrial
stock prices fell from a high of 381 to a low of 41!
The American market for European imports also dropped sharply as the
entire American economy went into shock; and, to compound trouble,
congress insisted on passing a high tariff law in 1930, against the advice of
almost all economists. Effective operation of the international economy
required that the United States import goods to allow foreign governments
to pay for American loans. Moreover, the raising of tariffs set off a chain
reaction as every government tried to protect itself against an adverse trade
balance leading to currency deterioration. The result was a drying up of
world trade that further fueled the economic downturn. The Americans,
additionally, continued to insist upon repayment of war debts, until finally in
1931 a general moratorium was declared. Well might Europeans complain of
American blindness, but these events only exposed Europe's vulnerability.
An economic depression was by no means a novelty. Severe and prolonged
ones had afflicted the world in 1873-1878 and 1893-1897. Others had been
shorter. They were usually preceded by a speculative and inflationary boom.
A typical boom had immediately followed the war, in 1918-1919, giving way
o a short and sharp slump in 1921-1922, which had in turn led to the
general prosperity of the years up to late 1929.
The exceptions to this we already know: Great Britain remained in a kind of
chronic slump, which was the result of her loss of overseas markets and
which was intensified by her refusal to devalue the pound in the 1920s.
Germany had experienced the strange agony of the massive inflation,
climaxing in 1923, because of the continuing struggle with France over war
reparations. The Communist revolution had largely cut Russia off from the
world economy, despite its limited toleration of capitalism from 1921 to
1928. Carving up the Hapsburg monarchy left Austria a charity case, and in
1931 a fresh wave of economic disasters started with the failure of the
Austrian central bank.
These exceptions may seem more numerous than the rule, but the United
States and most parts of Europe did enjoy relatively favorable economic
conditions between 1924 and 1930. But it turned out that this prosperity
rested on American loans and American markets, which now almost
vanished. A European economy still recovering from the trauma of the war
and its aftermath was too frail to weather this storm.
The Great Depression and Economic Theory
The business cycle had long had its ups and downs. If this downswing turned
out to be words than any previous one, the reason must be sought in the
profound structural changes heaped on top of a normal cycle. Fulcrum of the
world economy, the United States had not yet learned how to play that part,
as its erratic financial policies and high protective tariffs indicated. Deeper
changes were going on in the world. Policies of "autarchy" had developed
after the war and were to be perpetuated during the Great Depression; that
is, countries that were no longer prepared to trust the international order
tried to insulate their economies by tariffs, import quotas, or a managed
currency. During the 1920s, while sometimes readjusting the rate at which
their currencies were exchanged for gold, most nations clung to the gold
standard, which facilitated international trade by permitting currencies to be
freely exchanged in terms of gold. But beginning in 1931, when Great Britain
was driven off the gold standard, country after country left it in order to
protect themselves against a flight of gold leading to deflation and
unemployment. The flight from gold was followed by all kinds of nationalist
economic policies - exchange controls, import quotas, tariffs. International
trade was thus further impaired.
Economy Theory
1. According to the economic theory dominant throughout the nineteenth
century and still uppermost in the minds of public leaders, these periods of
depression represented a temporary disequilibrium that would soon right
itself.
2. The traditional wisdom did not see any role for government in an
economic crisis further than to provide "financial stability," which meant
balancing the budget and evading inflation. The idea of having the
government borrow and spend it order to counterbalance deflation in time of
depression ran counter to orthodox economic theory in 1929-1932.
Unpleasant no doubt in the short run, the orthodox policies was supposed to
restore economic health, like a nasty medicine needed to cure a disease.
3. Thus, at the cost of unemployment, deflation would lower prices and lead
to the recovery of markets. Interest rates would fall, again attracting capital
investment. The needle of the business cycle meter was supposed to hover
around full employment, and there would be maximum use of resources
under "normal" conditions. The natural operation of forces would soon draw
the economy back upward, unless a ham-fisted government in its ignorance
tampered with the delicate machinery. This machinery was supposed to
function under conditions of a stable currency, political stability, international
free trade, and a competitive economy.
4. This model was based on impressive theoretical work reaching back to the
later eighteenth century; it had the imprimatur of most of the great
economists of the "classical" nineteenth-century era, with only a few
outcasts dissenting. In the light of later analysis, based on sad experience,
this theory came to seem disastrously naive in assuming all kinds of ideal
conditions that did not exist in the real world. Perfect competition was
obviously lacking in an era increasingly prone to both corporate business
monopolies and allowance for wars, revolutions, dictatorships, the
dismemberment of countries, and all kinds of political factors.
5. Of course, unconverted advocates of the traditional economics might
argue that their remedy did not work because it was not tried; governments
did not adhere long enough to the Spartan measures necessary to make it
work. But facing massive unemployment, bankruptcies, and bank failures,
governments now could not resist demands to do something other than wait
patiently for the storm to run its course. Not knowing quite what to do, they
foundered, and their floundering perhaps made the situation worse. The
depression of the thirties found the old economic world dying and the new
one still struggling to be born. The result seemed to be the worst of both
worlds.
Whatever the causes, panic soon spread through Europe. In 1931, after the
World Court refused to allow Austria to enter a customs union with
Germany, that economically distressed country collapsed. The central bank
failed, touching off a panic that threatened Great Britain next. President
Herbert Hoover of the United States proposed a moratorium on all war debts
and reparations, but French opposition delayed its acceptance.
In Britain, a Labour government faced a flight of gold, which threatened the
pound. Elected in 1929, Labour had taken office with Liberal support. As
unemployment soared, payments to the jobless under the national insurance
program strained the budget. A special committee recommended cutting
unemployment benefits, and bankers in New York and Paris refused to lend
money to the beleaguered British unless this was done. The Labour cabinet
split. On August 24, 1931, Prime Minister Ramsay MacDonald, Chancellor of
the Exchequer Philip Snowden, and some other Labour ministers joined
Conservative and Liberal politicians to create a "national" government;
elections in October gave this coalition an overwhelming victory. But the
action divided the Labour party and left scars that were long in healing. The
party expelled MacDonald and his friends a traitor.
Bowing to the edict of the international banks did not save Great Britain
from being driven off gold, which happened on September 20. The whole
episode reflected the confusion of policy. Labourites and, in Italy, Fascists
were as uncertain what to do about the economic blizzard as anyone else.
The only thing that was indisputable was the continuing catastrophic
collapse. Unemployment rose to 22 percent in Britain, and industrial
production sagged to 84 by 1932 (1929 = 100). This was much better than
other countries did, but Britain started from a lower base. In 1932, French
production stood at 72 percent of 1929, German and American at barely
more than half (53). In July 1932, world industrial production was 38
percent less than in had been in June 1929. Few parts of the globe escaped,
and there were an estimated thirty million people in the world seeking vainly
for work.
Historian Arnold Toynbee called 1931 the annus terribilis, the terrible year.
This year of descent into the economic depths of mass unemployment,
hunger, breakdown of international exchange, failure of great financial
institutions was also a year of floundering governments, the rise of the
National Socialist party in Germany, and Japan's absorption of Manchuria.
Japan's move, at least partly inspired by economic desperation, later looked
like the beginning of the decay of international order leading to World WAR
II. From the vantage point of a despairing West, caught in what looked like
the last capitalist crisis, Stalin's First Five-Year Plan appeared as a beacon of
hope. In fact, however, Soviet Russia went through the experience of the
Communist government's forcible extermination of peasant landed property,
a veritable war that cost millions of lives.
In the ensuing years things got a little better in some places. Apparently
saved by what the experts regarded as a disaster, the British economy
improved after Britain's departure from the gold standard resulted in a
substantial devaluation. The recovery that took place between 1932 and
1937 reached a sort of boom in 1937, when unemployment fell to a mere 9
percent, low for the interwar years. But it rose to 13 percent in 1938-1939.
Worldwide, by 1937 the indices of economic activity had returned to the
1929 level. France had not climbed back quite this far; Germany just about
had.
One of the most punishing features of the depression had been the drastic
fall in agricultural prices, together with other primary products. The years
from 1925 to 1928 brought good harvests all over the world, the latter a
record in wheat. The price of grain tumbled just as the industrial and
financial slump hit, compounding the crisis. Loss of urban and international
markets afflicted farmer’s already in trouble from overproduction and,
frequently, from a burden of debt incurred in expanding production and
buying agricultural machinery. With unemployed workers suffering from
hunger, the sight of farmers refusing to harvest crops because the price was
too low to make it worthwhile drove home the bitter lesson of poverty in the
midst of plenty, the curse of Midas fallen on man. But by 1936 agricultural
prices had risen somewhat.
Conclusion and Economists Views
The Great Depression in U.S. history, the severe economic crisis supposedly
precipitated by the U.S. stock-market crash of 1929. Although it shared the
basic characteristics of other such crises, the Great Depression was
unprecedented in its length and in the wholesale poverty and tragedy it
inflicted on society. Economists have disagreed over its causes, but certain
causative factors are generally accepted.
1. The prosperity of the 1920s was unevenly distributed among the various
parts of the American economy-farmers and unskilled workers were notably
excluded-with the result that the nation's productive capacity was greater
than its capacity to consume.
2. In addition, the tariff and war-debt policies of the Republican
administrations of the 1920s had cut down the foreign market for American
goods.
3. Finally, easy-money policies led to an inordinate expansion of credit and
installment buying and fantastic speculation in the stock market.
As seen above, the American depression produced severe effects abroad,
especially in Europe, where many countries had not fully recovered from the
aftermath of World War I; in Germany, the economic disaster and resulting
social dislocation contributed to the rise of Adolf Hitler. In the United States,
at the depth (1932-33) of the depression, there were 16 million
unemployed-about one third of the available labor force. The gross national
product declined from the 1929 figure of $103,828,000,000 to
$55,760,000,000 in 1933. The economic, agricultural, and relief policies of
the New Deal administration under President Franklin Delano Roosevelt did a
deal to mitigate the effects of the depression and, most importantly, to
restore a sense of confidence to the American people. Yet it is generally
agreed that complete business recovery was not achieved and
unemployment ended until the government began to spend heavily for
defense in the early 1940s.
References
1.
2.
3.
4.
5.
6.
7.
8.
D. Wecter, The Age of the Great Depression (1948, repr. 1956)
M. Schlesinger, Jr., The Crisis of the Old Order (1957)
D. A. Shannon, ed., The Great Depression (1960)
U. Romasco, The Poverty of Abundance (1965)
G. Rees, The Great Slump (1970)
C. P. Kindleberger, The World in Depression (1973)
D. M. Kennedy, Freedom from Fear (1999)
T. H. Watkins, The Hungry Years (1999).