Many textbooks simply link the Great Crash and
the Great Depression together - what caused the Great Crash is
assumed to have caused the Great Depression which followed it.
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.
Their explanations are VERY complicated and theoretical, but
some of their main ideas (MUCH simplified) are:
1. Explanations at the time
a. Basically, at the time, people hadn’t a
clue what had caused the depression. Herbert Hoover argued
that it was the European financial collapse of 1931 that turned
it into the Depression; (so it was Europe’s fault, not
America’s).
b. 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. This was certainly what Roosevelt believed,
and his answer was simply to pump money into the US economy;
increased spending, however, did not cure the Depression.
2. Great Crash
a. You will often hear it said that the Great Crash didn’t
cause the Great Depression. There were only 1.5 million
shareholders, and only 600,000 speculators – so why should their
misfortune cause a Depression in a country of 123 million?
b. 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.
3. The Fed
a. (‘The Fed’ was
the US Federal Reserve – the American ‘Bank of England’.)
In the 1940s, Milton Friedman came up with a theory about the
cause called ‘monetarism’ – he believed that price changes were
caused by a reduction of money in the economy. He therefore
blamed the US Federal Reserve which in 1931 raised interest
rates – which, he claimed, led to a reduction in the money
supply. His famous saying was that ‘the Fed put the Great in
the Great Depression’.
b. This was made
worse,
Friedman added, when the banks began to go bankrupt after 1931,
and because the amount of money in the economy was linked to the
Gold Standard (meaning that the government would only issue as
much money as it could redeem in gold).
4.
Tariffs
a. In
1930, fearing for the US economy, the government passed the
Smoot-Hawley Tariff – a new, even
heavier tariff law.
b. Sixty countries passed
retaliatory tariffs in response and world trade slumped.
This damaged US industry, especially agriculture.
5.
Maldistribution of wealth
a. Nowadays, historians think 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
poverty.
b. 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.
6.
Weaknesses in the economy
You will remember
that Agriculture, and the Coal, Iron and Textiles industries
were all experiencing problems in the 1920s. When
the Depression started, they were not strong enough to cope, and
collapsed quickly.
7. Cycle
of Depression
As more banks and
companies failed, and people were put out of work, they had less
to spend, and so more companies went bankrupt and made their
workers unemployed etc. Once the Depression had
taken hold, it simply spiralled down worse and worse.