The Great Depression

The Great Depression

In this paper, I will review some of the causes that contributed to the Great Depression. 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 of that decade. The next topic to be covered is the dramatic crash of the stock market on "Black Thursday", October 24, 1929 when 16 million shares of stock were quickly sold by panicking investors who had lost faith in the American economy. Lastly, I will discuss what went on during the height of the Depression in 1933 when nearly 25% of the Nation's total work forces, 13 million people, were unemployed.

The start of the 1920's saw a stock market boom in the United States that brought about a false sense of optimism. Executives and economists believed that the newly established Federal Reserve could stabilize the economy, and that the rise of technological progress assured rapidly increasing living standards and expanding markets. The U.S. Federal Reserve attempted to raise interest rates in 1928 and 1929 to discourage stock speculation with little to no success. The speculation continued to bring with it the initial recession. Almost everyone was caught by surprise. Company's cut back their own plans for further purchase of durable goods. Firms making durables cut back production. The result was unemployed consumers and those who feared they might soon be out of work cut back purchases of consumer durables, and firms making consumer durables faced dropping demand as well. Falling prices and deflation during the Depression brought about contractions in production, which triggered additional falls in prices. With prices falling at ten percent per year, investors calculated that they would earn less profit investing now than delaying investment until the next year when their money would stretch ten percent further. Banking panics and the collapse of the world monetary system had cast doubts on everyone's credit, and reinforced their belief that now was a time to watch and wait. Increasing unemployment, falling production, and falling prices, hastened the slide into the Depression, which continued throughout the 1930's.

Another contributing factor was the ever-widening disparity of wealth between the well-to-do and the middle-income citizens that made the U.S. economy unstable. For our economy to function properly, the total demand must be equal to total supply. The economy at that time had an extremely unequal distribution of income that did not assure that demand would equal supply. What happened in the 1920's was that there was an oversupply of goods. It was not that the surplus produced by industrialized society was not wanted, but instead those who needed the products could not afford to purchase more, where as the wealthy were satisfied by spending only a small portion of their income. 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. The country counted on credit sales, and luxury spending and investment from the rich. The economy was also reliant upon luxury spending and investment from the wealthy to stay afloat during the 1920's. The significant problem with this reliance was that luxury spending and investment were based on the country's wealthiest citizen's confidence in the U.S. economy. If conditions were to take a downturn (as they did with the market crashing in the fall and winter of 1929), this spending and investment would slow to a halt. While savings and investment are important for an economy to stay balanced, the excessive levels did not bode well for the economy. Greater investment usually meant greater productivity. However, since the rewards of the increased productivity were not being distributed equally, the problems of income distribution and of overproduction only made things worse. Lastly, the search forever-greater returns on investment lead to widespread market speculation.

This mass speculation went on throughout the late 1920's. In 1929 alone, a record volume of 1,124,800,410 shares was traded on the New York Stock Exchange. From early 1928 to September 1929, the Dow Jones Industrial Average rose from 191 to 381. This kind of profit was irresistible to investors. Company earnings became a subsidiary priority. As long as stock prices continued to rise, huge profits could be made. One such example is the RCA Corporation, their stock price increased from 85 to 420 during 1928, even though it had not yet paid a single dividend. Even with these returns of over 100%, there was no way for the investors to determine the true values of stocks at that time. Through the availability of buying stocks on margin, you 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. Smith could buy 1 share of the company by putting up $10 of his own, and borrowing $75 from his broker. If Mr. Smith sold the stock at $520 a year later, he would have turned his original investment of just $10 into $441.25 ($520 minus the $75 and 5% interest owed to the broker). That makes a return of over 3400%! Investors' went crazy over the proposition of high profits and this drove the market to absurdly high levels. By mid 1929, the total of outstanding brokers' loans was over $7 billion; in the next three months, that number would reach $8.5 billion. Interest rates for stockbroker loans were reaching the sky, going as high as 20% in March 1929. 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 were still optimistic. Speculators continued to flock to the market. Then, on Monday October 21, prices started to fall quickly. The overall volume of stock trading was so great that the stock ticker fell behind. Investors