Crash and depression

Going Deeper

The following links will help you widen your knowledge:

BBC Bitesize on:

- the Crash from BBC Bitesize

- the Depression

It is essential that you listen to George Bailey explain the Crash in the film It's A Wonderful Life. 

AQA-suggested Interpretation of the Great Crash:

Frederick Lewis Allen, Only Yesterday

This huge topic is really two topics, although your textbook may treat it as one. 

The first issue is:
• Why was there a Great Crash on the American Stock Market in 1929? 
It is the easier question to answer. 

The second is much harder:
• Why was there a Great Depression in the 1930s? 

Why was there a Great Crash in 1929?  [WISP]

Historians are fairly much agreed why the Wall Street Crash of 1929 happened:

1. Wall Street Overheated

   • In the economic 'Boom' of the early 1920s, confidence was hgh and many people considered buying and selling shares a safe way to make money quickly (see Source A). 

   • Between 1924-29 the value of shares rose 5 times (which encouraged bolder trading).

   • Share prices rose way beyond what the firms they were shares were worth; only speculation kept up the over-inflated prices. 

2. Insider trading & corruption

   • Some firms which were not sound investments floated shares (e.g. one was set up to develop a South American mine which did not exist), but people still bought them, because they expected to make a profit in the bull market. 

   • The Senate Committee set up to investigate the Great Crash found that there was a corruption and 'insider-trading' between the banks and the brokers. 

3. Speculation

   • Many people became speculators - 600,000 by 1929. 

   • Poorer investors were buying shares 'on margin' (borrowing 90% of the share value to buy the shares, hoping to pay back the loan with the profit they made on the sale).  American speculators borrowed $9bn for speculating in 1929. 

4. Panic

   • There were losses of confidence in March and September (when an economist called Roger Babson forecast a crash), but the banks papered over the cracks by mass-buying of shares to steady the market. 

   • On Thursday 24th October 1929, nearly 13 million shares were sold in a panic, and prices crashed. 

   • The banks tried to shore up the market again, but on Monday there were heavy selling; the banks realised it was hopeless and stopped buying shares. 

   • Speculators panicked at the thought of being stuck with huge loans and worthless shares.  On Tuesday 29th October the market slumped again, when 16 million shares were sold. 

Why was there a Great Depression 1929-33?  [I'm Buggered]

Many textbooks (and websites such as the HistoryLearning site) just assume that the Great Crash inevitably led on to the Great Depression, but no economic historians think so today. 

Actually there was no reason why a stock market crash need have caused the Depression, so economists have tried to find reasons why the Crash slid into Depression.  Many ideas have been advanced, and the truth is probably that the cause of the Great Depression was all the follwing factors interacting together.

Their explanations are complicated and theoretical, but the main ideas (MUCH simplified) are:

1. International trade

   • President Hoover argued at the time that it was the European financial collapse of 1931 and the consequent reduction in world trade that caused the Depression; (so it was Europe’s fault, not America’s). 

   • In 1930, fearing for the US economy, the government passed the Smoot-Hawley Tariff – a new, even heavier tariff law.  Sixty countries passed retaliatory tariffs in response and world trade slumped.  This damaged US industry, especially agriculture. 

2. Maldistribution of Wealth

   • In the 1990s, many historians argued that a major cause of the depression was the inequality of wealth in America.  There were some extremely rich people, and huge numbers of extremely poor people – the top 5% owned a third of the wealth, while 40 per cent of the population were living in pover. 

   • It wasn’t that there was too little money, but it wasn’t in the hands of the people who would spend it.  Consequently, Americans produced too much and bought too little, and prices plummeted. 

3. Bank failures

   • When the Great Crash happened, thousands of speculators who had borrowed on margin' defaulted.  This led some banks to go bankrupt - particularly banks in the poorer immigrant areas.

   • When people saw that banks were going bankrupt, they rushed to take out their money ...  causing those banks to go bankrupt.  More than 7,000 banks failed 1929-33. 

   • The collapse of the banking system led banks to restrict their lending, worsening the economic downturn. 

   • Before 1935, when a bank failed, investors lost their money.  The savings of millions of people, many of them retired and with no other income, were wiped out.  The closure of the Bank of the United States (December 1931) alone affected 400,000 depositors.  Those people had to stop spending, creating an economic downturn.

4. Underlying economic weaknesses

   • You will remember that the Coal, Iron and Textiles industries were all experiencing problems in the 1920s, and that there was a problem of overproduction in Agriculture.  When the Depression started, they were not strong enough to cope, and collapsed quickly. 

   • Banks became wary of lending, which reduced the amount of money in the economy ...  which led to reduced demand and economic recession. 

   • A study in 1983 blamed over-investment for producing too many goods; another in 1987 blamed the consequent low levels of profitability, leading to job losses.

5. Gold Standard

   • The 'Gold Standard' was the rule by which the amount of money in the economy was linked to the amount of gold in the US Federeal Reserve.  This limited the supply of money in the economy, and helped limit (especially government) spending and worsened the recession.

   • Countries that abandoned the gold standard earlier (e.g. Britain left the gold standard in 1931) recovered more quickly from the depression. 

6. Great Crash

   • Scholars disagree about how – or even whether – the Great Crash helped to cause the Great Depression (see Source D).  There were only 1.5 million shareholders, and only 600,000 speculators (and some of them were wealthy enough to be able to stand losing money – many actually BOUGHT shares while share prices were very low) – so their misfortune did not directly cause a Depression in a country of 123 million. 

   • However, you will remember that much of the bull market had been financed by loans – in 1929 brokers’ loans amounted to $8.5 billion.  Much of this money had been advanced by the banks, and by the big companies (in 1929, 200 companies controlled half of US industry).  So when the speculators crashed, many banks went bankrupt, and half of US businesses was damaged, so the whole US economy suffered. 

7. Expectations – the Cycle of Depression

   • A major cause of the Depression was loss of confidence.  People who in fact had plenty money did not go out and spend it 'just in case things got bad'; this reduced spending, and firms struggled/went bankrupt and made their workers unemployed/reduced their wages. 

   • 109,000 companies folded 1929-33, depriving millions of people of their jobs and – in country without a welfare state – of their income.

   • As more companies struggled/went bankrupt and made their workers unemployed/reduced their wages, those people had less to spend, and so more companies struggled/went bankrupt and made their workers unemployed/reduced their wages.  Once the Depression had taken hold, it simply spiralled down worse and worse. 

    

   Economic Theories

8. Reduced Demand (Keynes)

   • The explanation of British economist John Maynard Keynes in 1936, who wrote General Theory of Employment, Interest, and Money, was that the cause was a DROP IN SPENDING, caused by people saving too much.

   • In 1931 he blamed "a common tendency to withdraw money from the banks and keep resources hoarded in cash ...  in the country as a whole as much as $500 millin was hoarded".

9. Economic policies and 'the Fed' (Friedman/ Bernanke)

   • In the 1940s, Milton Friedman and Anna Schwartz came up with a theory about the cause called ‘monetarism’ – they believed that price changes were caused by a reduction of money in the economy.  He therefore blamed the policies of the US Federal Reserve which in 1931 raised interest rates – which they claimed, led to a reduction in the money supply.  Friedman's famous saying was that ‘the Fed put the Great in the Great Depression’. 

   • In a speech in 2002 Ben Bernanke, then Governor of the Federal Reserve, agreed, blaming the Fed for "the sharpest rise in [interest rate] in the whole history of the Federal Reserve", for failing to support the banking sytem, and for a failure of leadership.  He concluded: "I would like to say to Milton and Anna: Regarding the Great Depression.  You're right, we did it.  We're very sorry.  But thanks to you, we won't do it again."

10. Debt-deflation (Fisher)

    • In 1933 the economist Irving Fisher wrote an article 'The Debt-Deflation Theory of Great Depressions'. 

    • His argument was that when Great Crash happened, people tried to get rid of their debts.  This led them to selling assets and cut spending ...  which then reduced prices and caused the economic downturn. 

Basic notes on the Causes of the Depression from BBC Bitesize

Notes from an article blaming maldistribution of wealth

YouTube

• Milton Friedman explains his ideas

• Video for Mrs B's History class - clear overview