In October 1929 the ‘Roaring Twenties’ came to an abrupt end as the Wall Street Crash heralded the beginning of the Great Depression. Many countries across the world felt the consequences of this unprecedented economic downturn during the 1930s, with worldwide GDP estimated to have fallen by 15% between 1929 and 1932. The United States was particularly hard hit as it grappled with a 30% reduction in its GDP.
To understand the global nature of the Great Depression, it is first necessary to examine the causes of the downturn in the US – where the recession originated. The stock market crash is an obvious place to turn to. On 28 October 1929 – a day known as “Black Monday” – the Dow Jones saw a decline of 13%, decreasing the following day by a similar margin. Whilst this shock did not initially spread to the vast majority of the population who were not shareholders, it spelled uncertainty for the future prospects of the economy that pertained to ordinary Americans. The optics of such a crisis – despite being initially contained to Wall Street executives – were gloomy, leading to a scramble to save money. The theory that economic uncertainty reduced spending is central to the Keynesian explanation for the Great Depression.
John Maynard Keynes (1883-1946) posited that reduced spending destroyed business opportunity and production, catalysing other consequences such as layoffs. Even prior to the stock market crash of 1929, there were visible signs of decreasing demand. The boom of the 1920s saw an unprecedented – and indeed unsustainable – level of spending. By the summer of 1929, many Americans grew pessimistic about the state of the economy. What’s more, a period of deflation between 1927 and 1928 encouraged people to save rather than spend. This was accompanied by an increase in interest rates to 6% in 1929.
It was not until the banking crises between 1930 and 1931 that this downturn became a fully fledged depression. Following runs on the banks, the Roosevelt administration declared a four-day bank holiday in 1933 and pressured every bank to prove their solvency. After this event, 9,000 banks had closed – 30% of all those that were active in 1929. This reduced circulation by 35%, leading to a price drop of 33%. Furthermore, due to a reluctance from the Federal Reserve to bail out failing banks, banks were now exceedingly cautious with their loans, dampening investment. Again, the Federal Reserve raised interest rates in 1930 and 1931, increasing the real value of debts, leading to defaults on loans. This added to the pressures that banks were facing, as many were trying to call in their loans to satisfy those demanding withdrawals. Monetarist economists, led by Milton Friedman and Anna Schwartz, believed that the shrinking of the money supply was the primary factor which turned this “ordinary” recession into the Great Depression. Furthermore, they blamed the Federal Reserve for allowing the recession to spiral out of control by raising interest rates and not providing any bailouts for failing banks.
Due to America’s aforementioned deflation, exports became cheap; meanwhile, imports remained low due to limited spending. This gave the US a large trade surplus which was accompanied by significant inflows of gold since it was on the gold standard. Despite strengthening the dollar, this destabilised the currencies of other countries on the gold standard. These countries had to subsequently raise interest rates to bring about deflation and help reduce their outflows of gold. Nonetheless, by raising interest rates they were also reducing output and increasing unemployment. Banks would often use their gold reserves to back up their loans; when these reserves diminished, banks cut down on their loans, which the output of the economy and resulted in layoffs. Issues with the gold standard first became visible in May 1931, when Austria’s central bank, the Credit-Anstalt, collapsed. Foreign investors withdrew their money, converting the currency into gold. It’s no surprise that the resulting outflow of gold from Austria destabilised the currency. The Austrian government was forced to freeze all foreign deposits to stop the outflow of gold; at the same time, the crisis triggered runs on banks in Germany and the rest of Europe. Countries that abandoned the Gold Standard earlier tended to fare better. Britain, whose gold reserves had fallen from £200 million to £5 million between 1929-31, was the first country to abandon the Gold Standard in 1931 to facilitate their recovery, and by the beginning of the Second World War the Gold Standard was defunct as a method of foreign exchange.
Protectionist policies from the US also contributed to a decline in global trade and the onset of Depression in other countries. American farmers were facing increased competition from Europeans in the 1920s, and lobbied Congress for some tariffs to increase their competitiveness. The Smoot-Hawley Tariff Act was passed in 1930, putting taxes averaging 20% on around 20,000 different industrial and agricultural goods. Other countries naturally retaliated with their own tariffs, harming global trade at the end of the 1920s. This led to a decline in exports a reduction in output. Furthermore, as the Federal Reserve increased interest rates at the end of the 1920s, American banks reduced their lending to foreign countries, which contributed to minor recessions between 1928 and 1929 in countries such as Germany and Brazil, even before America was to fall into the Great Depression.
There was no one main cause of the Great Depression. The reduction in demand at the end of the 1920s started the recession; this was only worsened by the banking crises that caused a large shrink of the money supply. Protectionist policies and the gold standard exacerbated the downturn, increasing its reach to the rest of the world.
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https://www.britannica.com/story/causes-of-the-great-depression
Milton Friedman, Anna J. Schwartz (1965): The Great Contraction, 1929-33