Great Depression

Overview of the Great Depression

The modern economy moves through a business cycle of periods of strong economic growth and prosperity that are followed by periods of slow, or no growth that are economically painful, because people lose money and are unemployed. The business cycle became a regular part of life after the Industrial Revolution. During the late nineteenth century, the global economy swung back and forth between economic booms and economic depressions. Generally, there was a major depression happening roughly ever twenty years. While these economic depressions were painful, the economy would always recover stronger than it had been before the depression. Before the Great Depression, many economists considered depressions a "necessary evil" for having a growing economy.

World War One caused a large amount of economic damage to the global economy and it suffered a short and deep depression in the years after the war. However, by 1924, the world economy began to improve as the American economy grew stronger and Europe began to recover from the effects of the World War. The United States emerged from World War One as the driving force in the world economy. Undamaged by the war, the American economy provided the base for the world economy throughout the 1920’s. For example, during this period, the unemployment rate in the United States was 4% while in Europe is ranged from 10% to 20%.

One reason for the strong growth in the United States was because American companies embraced the new technologies of the time such as radio and cars. These American companies became very profitable and valuable to the owners of the companies. Ownership in a company is held in shares of stock, which are bought and sold on stock markets, like the New York Stock Exchange. During the 1920’s, the stock prices of many American companies began to rise in value and many Americans invested in the stock market to make money. People began to see buying stocks as way to get wealthy.

By 1929, the stock market had become a "speculative bubble". This is when people buy stocks because they expect them to go up in price so they can sell them for a profit. In a speculative bubble, people ignore the real value of a stock. The problem is that a speculative bubble is not sustainable because when prices stop going up investors panic and try to sell. This happened in October 1929, and when the speculative bubble burst the New York Stock Market crashed. In two weeks more than $30 billion in market wealth was lost. By June 1930, stocks had lost 80% of their value. The stock market crash financially ruined investors and they were forced into bankruptcy. This financial collapse set in motion a “bank panic” where people tried to pull their money out banks. However, the banks only had enough money to pay a small fraction their depositors. Unable to pay people their money, the banks were forced into bankruptcy and the money supply in countries shrank, which made slowed the amount of economic activity

The combination of the stock market crash and bank failures created a vicious cycle in the American economy. Less economic activity resulted in workers losing their jobs, which meant they could no longer buy things in the economy, and as businesses were unable to sell goods they laid-off workers and went bankrupt, causing higher unemployment. The American economy collapsed into the Great Depression. By 1932, the American economy had shrunk by 47% and roughly 30% American workers were unemployed. There was little in the way of government support or protection for these unemployed workers to fall back upon. As a result, millions of Americans who considered themselves hard working members of the middle class found themselves reduced to poverty, with no hope of improving their condition.

In 1936, British economist John Maynard Keynes published his book “The General Theory of Employment, Interest and Money” that explained how causes of the Depression and proposed a solution. Keynes believed in the basic capitalist ideas that free markets produce the greatest wealth for society, and that economic growth would improve everyone’s standard of living. However, he also recognized the problem of the business cycle. He believed that a capitalist economy was unstable and that, under some conditions, it could fall into long depressions. While the economy might improve in the long run, he saw that millions of people were suffering for no good reason. Keynes made the point that, “In the long run, we’re all dead” to argue that the government should act to stop this economic pain. Keynes said that governments should take a role in managing their national economies through controlling the levels of government spending, taxation, and the size of the money supply. The essence of Keynes’ theory was that the government should increase spending in public building projects to put people and businesses back to work. These people would then spend the money they earned, which would stimulate more economic activity and move it out of depression. Keynes was opposed to complete government control of national economies, as practiced by dictatorships in Nazi Germany and the Soviet Union, because it took away personal freedoms. Instead, Keynes said that governments could manage the economy like a giant machine and control the business cycle.

Keynes believed that his ideas were about more than just ending the hardship of the Great Depression. He felt they were about saving capitalism and democracy, and stopping communism and Nazism (which were gaining power and popularity in Europe. The importance of Keynes' ideas was described by one of his students who said, "what Keynes supplied was hope: hope that prosperity could be restored and maintained without the support of prison camps, executions, and bestial interrogations”.

Keynes’ theories became the basis for economic policy for democratic governments in Europe and the United States during Depression. An example of this was Franklin Delano Roosevelt, who became president of the United States in 1932. Roosevelt enacted an economic program called the New Deal to save the American economy through government spending to create work and management of the economy. The New Deal program hired unemployed workers to build roads, bridges and parks. It also regulated banks and the stock market to make it so problems in banks and the stock market cannot do terrible damage to the whole economy. For example, the New Deal banks to buy insurance so that if they went bankrupt the people who deposited the money in the bank would be fully repaid. In addition, the New Deal created Social Security to provide government pensions to people who lost their retirement saving. While government programs, like the New Deal, helped with the worst effects of the Great Depression, the world economy continued to have problems throughout the 1930's up until the beginning of World War Two.

Source # 1 - Video describing the impact of the Great Depression on Belgium -click here