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Great Depression

The Great Depression is the period of history that followed "Black Thursday", the stock market crash of Thursday, October 24, 1929.

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The British Monetary Crisis

It is widely supposed that the events in the United States triggered a world-wide depression, which led to deflation and a great increase in unemployment.

However, it is also considered that the great depression was actually triggered much earlier in Britain, around when Britain abandoned the gold standard in World War I.

Before 1914, London had been the world's financial center. When the war started in August shipments to England of gold, silver, and goods from all over the world were immediately disrupted. The shortages put London's banks and stock exchange in crisis. To deal with the crisis they closed down for a few days. When the banks and stock exchange reopened, a debt moratorium was declared. The Bank Charter Act[?] of 1844, fixing the bank reserve ratio, was suspended. This suspension of the Bank Charter Act put Britain unofficially off the gold standard.

As the war continued and the government's costs increased, the government used the suspended Bank Charter Act to pay off their war debts. They did this by simply printing more money—far in excess of gold reserves. This caused considerable inflation of the pound on British domestic markets, and noteworthy inflation of the pound on international markets.

By 1920, after the war was over, inflation had proceeded to such an extent that prices of goods in Britain had tripled, and the gold value of the British pound had fallen 10 percent on world markets. The pound had dropped from 7.313 grams of gold (US$4.86) down to 6.620g of gold (US$4.40). In 1924 the US Federal Reserve adopted the "easy money" policy, making it easier than it had been to get bank loans. The decision was made in order to combat a decline in business activity and to encourage international capital flows. This action was also taken to help Britain to import enough gold to return to the gold standard the following year.

Monetary troubles worsened when, on April 28, 1925, England went back on the gold standard at the artificially high rate for the pound of US$4.86. At the time the pound should have been pegged at around US$3.50 to reflect the larger amount of circulating British currency after the war. Thus, the British pound was overvalued vis-à-vis gold and the US dollar. This caused British products to appear relatively overpriced in the world markets. These problems were not caused by the gold standard as such, but was caused by the unrealistic valuation of the pound when it was reestablished.

The immediate effect of the British revaluation was to price British goods out of the world market. For instance, U.S. importers who had been paying US$4.40 to buy a British pound's worth of British wool or coal now had to pay about 10 percent more. Naturally the rise in the international price of British goods led to a commensurate drop in British exports. British exports declined at a time when England was heavily dependent on exports. Great Britain experienced imports chronically in excess of exports accompanied by persistent balance-of-payments deficits and outflows of gold reserves. Her banks, factories and mines were hard hit.

It was decided that, in order to keep the factories and mines open and men working, money wages would have had to be adjusted downward to reflect the overvaluation of the pound. This drop in money wages would not have affected real wages because a return to gold had increased the value of the pound. But the unionized workers resisted and refused to work for less. Many went on the dole and many went out on strike. In 1926 the over-valued pound and the attempt to reduce prices and wages to compete overseas provoked a general strike. Prices and production were seriously disrupted.

Around the same time as the revaluation of the British pound, other European nations returned to gold-convertible currencies as well. Unfortunately they created a weak monetary system known as the "gold exchange standard," where currencies were pegged primarily to the British pound and the American dollar rather than to gold itself. The gold exchange standard created a pyramid of paper claims upon other paper claims, with gold playing a far lesser role.

As a result of the British pound revaluation, Britain suffered a deflationary depression for the rest of the 1920s. Moreover, to help Britain return to gold at the prewar exchange level, the Federal Reserve had pushed down interest rates in 1924, and did so again 1927, cutting them from 4% to 3½%. This ignited a fateful inflationary boom in the U.S. In 1927 the rate was cut partly in order to help Britain to stay on the gold standard. However the supply of credit was eased just as a speculative boom was starting on the stock market.

Through 1928 and 1929 the US Federal Reserve's "easy money" policy had finally triggered a stock market boom in the US. The Federal Reserve did not take effective action to prevent the boom from getting out of control.

On 24 October, 1929 the New York stock market crashed. The Federal Reserve, whose easy money policy stoked the boom, suddenly tightened credit. This sudden tightening of credit had the effect of causing and then worsening a slump in the US economy, marking the beginning of the Great Depression.

Widespread bank failures and restrictions on lending by the surviving banks caused businesses of all kinds to go bankrupt. The US net national product fell by over half during the period from October 1929 until the end of 1930.

Throughout early 1931 there were many bank failures in Europe, in particular some of the major banking institutions in Germany. This resulted in the remaining German banks restricting their lending.

By September 1931 it was recognised that the US and France held 75% of world's gold stock. During the previous 6 weeks over £200 million worth of gold (around £12 billion in 2003 money) was withdrawn from London, causing a reserve crisis for Britain.

Finally, on September 20, 1931, England announced that she would again suspend gold payments and go off the gold standard. The consequences were disastrous. This triggered the move from classical to Keynesian economics. The Commonwealth (except Canada), Ireland, Scandinavia, Iraq, Portugal, Thailand, and some South American countries followed Britain off the gold standard in 1931.

The British monetary experiments played an important role in bringing about and prolonging the world depression of the 1930s.

The resulting US Federal Reserve's monetary policy, except for very brief periods in 1929 and 1936-1937 when it turned mildly dis-inflationist, was consistently and unremittingly inflationist in the 1920s and 1930s. This inflationism was the cause of the Great Depression and one of the reasons why it was so protracted.

The United States Stock Market Crash

On the global scale, the market crash in the USA was a final straw in an already shaky world economic situation. Germany was suffering from hyperinflation of currency, and many of the Allied victors of World War I were having serious problems paying off huge war debts and were experiencing bank failures. In the late 1920s the American economy at first seemed immune to the mounting troubles, but with the start of the 1930s it crashed with startling rapidity.

The reason the US appeared to be immune from the world-wide economic contraction was the commencement of the long-term policy of central-bank credit expansion. From the start of the US reserve bank in 1913 the US Federal Reserve was able to print money at will. The US reserve bank permitted the creation of new money from nothing. This sudden influx of new fiat money led to overconfidence in the economy, an economy that appeared to be expanding at a time when the rest of the world was suffering. Unfortunately the rising money supply only created a short-lived illusion of strength and stability. It was an illusion because the money supply was not expanding on the back of increased economic productivity, but on the whim of the US Federal Reserve.

Prior to 1913, if the money supply in the US was going to increase, there needed to be significant increase of gold or silver in the economy. Gold or silver are items of value, and require a commensurate increase of economic activity to generate each unit of currency.

However, with the opening of the US federal reserve bank, for the first time credit could be created out of thin air without the demands of economic productivity necessary with the specie money used up until then. The US federal reserve had permission to begin a massive fraud. It was allowed to generate credit dollars without needing to back those dollars with anything—even though the US was still supposed to be operating in a 100% reserve currency at the time.

With specie, to create a silver dollar required twice the economic productivity that the creation of a silver half-dollar required. With US Federal Reserve credit, however, no productivity at all was necessary for the creation of money.

To make matters worse federal reserve credit was, to begin with, easily obtainable on the "easy money" policy begun in 1924. An apparent abundance of wealth and the roaring twenties was the result. This was reflected in the stock markets by a sudden upswing in the Dow Jones commodities index beginning in 1915, curving upward gradually, and finally tripling between 1923 and 1929—an unprecedented trend, and one that has not been seen since. The federal reserve permitted the US economy to have a party that it had simply not earned—yet.

Then, in early 1928, the Federal Reserve increased interest rates in response to the incredible amount of speculation on the stock market. This was an attempt to restrain the spending of these easily obtainable Federal Reserve dollars.

There was an incredible, and tragic, economic credit "bubble", similar to the dot-com bubble that burst in the late 1990s. The credit bubble burst on Black Thursday, and the stock market gains of the previous 17 years were all lost in the space of 30 months. This was followed by a deep and protracted depression—the Great Depression. It was time to pay for the party.


Dorothea Lange's Migrant Mother, depicts destitute pea pickers in California, centering on a mother of seven children, age thirty-two, in Nipomo, California, March 1936.

The USA's economy had been showing some signs of distress for months before October 1929. Business inventories of all kinds were three times as large as they had been a year before (an indication that the public was not buying products as rapidly as in the past), and other signposts of economic health—freight carloads, industrial production, wholesale prices—were slipping downward.

As the Great Contraction began in 1929, the Treasury and Federal Reserve increased their hoards of gold. The compulsion of the U.S. Treasury and Federal Reserve Bank to hoard gold between 1929 and 1933 was in sharp contrast to Treasury policy during the previous economic panic between 1892 and 1896. In the earlier period the Treasury felt duty-bound to redeem its paper currencies with gold on demand, and in so doing lost over 50 percent of its gold reserves. However, by doing so the Treasury was actually preserving the liquidity of the specie money supply, and was permitting the natural economic contraction to run its course and be over much sooner.

By contrast, all through the 1929-1933 period, except for a brief interval in the middle of 1932, the Treasury and Fed added to their gold holdings while the banking system collapsed as its reserves disappeared into the Federal Reserve.

Banks foreclosed on businesses, only to find that the businesses had used all their money, and the assets were unsaleable—then those banks themselves were unable to continue to operate. Factories were closed, and masses of factory workers lost their jobs. These workers were also consumers, but their consumption of produced goods trailed off when they had no work. The economy went into a terrifying downward spiral. This was a period of serious financial contraction.

Two policies exacerbated the depression. The first was the tight money policy of the Federal Reserve which restricted the money supply very suddenly after running for 17 years with a very loose monetary policy. The second was the recourse to protectionism with measures such as the Hawley-Smoot Tariff Act, which raised tariffs on imports in order to protect local producers who were being hurt by foreign competition. In response, many other countries also raised their tariffs, badly hurting US businesses that exported their goods. This led to a chain reaction of tariff increases which fragmented the world economy.

In the United States, Herbert Hoover was the president, and he tried to control the situation; however, he helped little. One of the major problems was that with deflation, the currency that one kept in one's pocket could buy more goods as the prices went down. The other was that there had been no oversight in the stock market or other investments, and with the collapse, many of the stock and investment schemes were found to be either insolvent, or outright frauds. Unfortunately, many banks had invested in these schemes, and this precipitated a collapse of the banking system in 1932. With the banking system in shambles, and people holding on to whatever currency that they had, there was minimal cash available for any activities that would cause positive change.

In Germany unemployment increased drastically, fuelling widespread disillusionment and anger. The institutions of the Weimar Republic, which had already been standing on shaky ground, started cracking in the years from 1930 to 1932 while Chancellor and finance expert Heinrich Brüning was trying to fix the economy by drastically cutting state spending. At the time, the NSDAP gained much popularity, winning the two general elections in 1932, which eventually led to the appointment of Adolf Hitler as Chancellor on January 30, 1933. (See Weimar Republic for details.)

Likewise, many Americans were disillusioned with their system of government, believing that Hoover's policies had driven the country to ruin. (Shantytowns populated by unemployed people at the time were often dubbed "Hoovervilles[?]" to highlight the President's fading popularity). During this period, several alternative and fringe political movements saw a considerable increase in membership. In particular, a number of high-profile figures embraced the ideals of Communism, though this would subsequently be used against them during the Red Scare of the 1950s. Radio speakers such as Father Charles Coughlin saw their listening audiences swell into the millions, as they sought for (and often found) easy scapegoats to blame the country's woes upon.

Roosevelt's "New Deal" in the USA

In 1932 the United States elected Franklin Delano Roosevelt to replace Hoover as president. With unemployment near twenty five percent of the workforce, he initiated a number of government programs to increase liquidity and provide jobs, which jointly are called the New Deal. Some believe that these actions helped bring the country out of the depression—though there is considerable controversy over the extent to which this is true—and provided some of the infrastructure, including roads that are still in use today. Roosevelt's first major action happened on his first full day in office on March 5, 1933 when he declared that a "bank holiday" would go into effect the next day that would close all United States banks and freeze all financial transactions in order to stop the run on bank deposits. When banks were finally allowed to open on March 13, depositors found that they would never again be allowed to withdraw the gold that they had deposited. This confiscation of wealth substantially reduced the rate of bank closures, and allowed the government to finance further "New Deal" programs. The United States Congress went to work on enacting New Deal legislation on March 9, 1933.

Because the US was still in a state of depression when it entered World War II, the New Deal's success is still debated. Much of the debate is centered around what point to measure the success from or what constitutes success. Those who measure success as return to the economic levels of 1928 argue that the New Deal was a failure. In 1928, the level of Gross National Product (GNP) was at 100 billion, and Consumer Goods[?] purchased was at 80 billion. By 1933, when Roosevelt took office, the economy had shrunk to a GNP of 55 billion and CGP[?] of 45 billion. Some argue, that the American economy had probably hit an economic peak around 1928, and that it would be unreasonable to return to those levels. By 1939 the US GNP had risen to 85 billion with a CGP[?] of 65 billion.

For those who view the New Deal as a failure, the reasons are open to debate. Some argue that the inherent instability of a market economy caused such a bad depression that even the well-chosen interventions of the New Deal could not correct it quickly. Others argue that the situation was worsened because this longest depression in US history was also marked by the greatest degree of government intervention in US history, although this claim is highly contentious.

It is known that Roosevelt's New Deal programs were initially struck down by the Supreme Court, so that his initial interventions in the economy were all halted. During this time the economy was on a slow improving trend. After the Court began to uphold his interventionist legislation, the economy took a sharp downward dip, which has been called a depression within a depression, from which it was only slowly recovering when the US entered WWII. Thus it is claimed by some that his intervention delayed the economic recovery that had been underway.

The Influence of the World War

Many believe that it was government-induced World War II spending that restarted world-wide economic expansion, but this is at best only partly true. Germany and Italy had "recovered" prior to WWII by making massive military and infrastructure investments. The US moved to full employment during WWII through massive military investments, but also by shifting a very large percentage of the potential work force into the military. While this was necessary, it meant the US economy had not returned to natural market conditions, and when the war ended a period of readjustment was necessary when millions of soldiers returned home. One of the purposes of the G.I. Bill[?] was to ease this transition. In countries such as France, England and the Netherlands, of course, the war caused tremendous harm, rather than being a source of economic revival. While war is always profitable to particular businesses, it causes social and economic dislocations that outweigh any stimulus effects it might have. It is interesting to note that in a single generation popular opinion went from viewing war as the cause of the Depression to being the cure for the Depression, in both cases with dubious causality.

The End of the Great Depression

By this time, business had been reinforced by government expenditures as a consequence of depression and the war. Between 1929 and 1933 unemployment soared from 3 percent of the workforce to 25 percent, while manufacturing output collapsed by one-third. Franklin Roosevelt's New Deal programs tried to stimulate demand and provide work and relief for the impoverished through increased government spending. The philosophy behind this was belatedly provided by the British economist John Maynard Keynes. Between 1933 and 1939, federal expenditure tripled, and Roosevelt's critics charged that he was turning America into a socialist state. But the cost of the New Deal pales in comparison with World War II. In 1939, federal expenditure was $9 million; it had increased tenfold by 1945. And war spending financially cured the depression, pulling unemployment down from 14 percent in 1940 to less than 2 percent in 1943 as the labor force grew by ten million. The war economy was not so much a triumph of free enterprise as the result of government deficit spending stimulating economic activity.

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