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The Great Depression

Causes and Effects of the Great Depression

INTRODUCTION

In the views of economist, perfect market is such a market which does not experience any kind of crashes, bubbles or recessions, but when human beings are the players, it is inevitable that these phenomena do not occur. The Great Depression is one of the live examples that how susceptible markets and economies can be, as the world economy experienced one of the worst economic blow. The beginning of the Great Depression was due to the stock market crash of 1929. The market crash of 1929 swept away investments of many people and it has shaken the world economy. Further, the failure of many banks added to the injury as savings of many people was wiped out even if they did not invest in the stock market. According to many researchers and scholars, the downfall of the market is not in the hands of people and it is difficult for human beings to avoid it, but with stiffer and better banking regulations, failures of banks could be avoidable (Jukes, 2008).

This paper will discuss about the stock market collapse of 1929 and other factors that contributed in the devastation of the world economy and which gave rise to The Great Depression.

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THE GREAT DEPRESSION

Depression can be defined as a long and severe period of downturn activities or when all the activity results in the downfall of an entity. In the terms of economy, economic depression can be defined as a period of recession when the businesses are not doing well. Generally this recession lasts for two or more years. Economic depression is characterized by a lot of unemployment, most of the businesses operating with diminishing output; reduce commerce and trade, sovereign debt defaults and bankruptcies, less of no availability of credit and volatility in the value of currency (Wheelock, n.d). Further, during the time of depression, as the confidence of the consumers fall down and because of which they do not reduce their investment activities, thus, resulting in shutdown of the economy. There are different views of different economist regarding the duration of the depression. According to some economists, depression covers only that period in which the economic activities are infected. On the other hand, some economists believe that the period of economic depression does not end up till the recovery of all the economic activities to its normal pace (Yadav and Shankar, 2009).

In line with the above definition, the economic recession experienced by the United States and the whole world after the collapse of U.S. stock market on October, 29, 1929 is considered to be as The Great Depression. The origin of the Great Depression was the United States, but within no time it entered in the Europe and then across the rest of the world. The period of the Great Depression lasted for around 10 years and resulted in unemployment, hunger, poverty and political unrest. In October, the 24th, 1929 the New York Stock Exchange (NYSE) was crushed. This day is regarded as the Black Tuesday in the history of the stock market in the entire world (Johnson, 2011). Because of this Great Depression, the majority of the people left with nothing as most of the savings made by them was invested in the stock market and nearly the entire amount invested by them in the stock market was lost away. This trend continued and on the next Tuesday most of the economist sensed the beginning of the Great Depression as the DJIA dropped by 12%. It also resulted in decline in international trade, product prices, tax revenue and personal income. According to some economists, if proper checks are not done even on capitalist economy, it can prove dangerous as it could be one of the reasons behind the Great Depression. Because of such views of some economists, some of the countries completely revamped their political structure and adopted either fascism of socialism. The best example is of Germany which adopted fascism structure after the Great Depression (Reid, 2011).

CAUSES OF THE GREAT DEPRESSION

The Stock Market Crash of 1929

After the first world war, that is around 1920’s the America was experiencing prosperity and peace and its cultural and economic activities were on boom due to industrialization and introduction of advance technologies such as automobile and radio. The period after world war first also known as Roaring Twenties, the average price of Dow stock was climbing and because of this most of the economist felt that investment in the stock of the most power full economy will be the safest investment. Due to this, most of the investors, invested their hard earned money in aggressively purchasing of stocks. At that time, investors were ready to buy the stock even on their margin. That means the investor will borrow 90 dollars worth of stock if he invests 10 dollars. According to this, if the stock rises by one per cent, investors will get ten percent. But, the same is applicable if the stock will not perform in the market. That is, at that time even minor losses are proved very fatal (Bye, 2010). Moreover, if the stock does not able to perform at all, in such situation the investor will lose his entire investment and even have to owe money to the middle man. The era between 1921 and 1929 witnessed many new millionaires as the stock market inclined from sixty to four hundred. The people started dealing in stock trading more vigorously as it is the easiest way to earn bucks. Moreover, those who do not have liquidity, mortgage their home or borrowed from a third party or even put their saving of the entire life in some of the most attractive stocks such as RCA and Ford. In the views of investor, stock market was not a gamble and they believed it will defiantly yield higher returns. Before investing in any stock, very few people took the pain to understand the financial position of the company. Moreover, many fraudulent companies sensed the opportunity to fool the innocent investor in order to make money. Finally, stock market crash was never in their mind and the trend of rising in the stock level continues (Vance, 2011).

In order to curb the stock market and the economy of the nation, the Federal Reserve increased the rate of interest abruptly in 1929. Due to this the stock market started to fall. Finally, on October 24th 1929, investors started to sell their stock as by now they understood that it is not the stock boom rather it is just over inflated speculative bubble. In order to get their money as quickly as they can, the majority of investors started to sell out their stocks (Krugman, 1979). But, once when the stock market crashed on 28th and 29th of the October 1929, many of the millionaire marginal investors went bankrupt. In the next month that is in November 1929 the stock market Dow crashed from 400 points to 145 points. Further, reports show that, within three days, around five billion dollars were erased from the capital market as most of the stocks on the New York Stock Exchange were crushed. In the last two months of the year 1929 around 16 billion dollars worth market capitalization was lost from the New York Stock Exchange (Temin and Barrie, 1990).

Further, as in the views of many economists, the return from the investment in the stock market was surety, so many of the banks also put their deposits in the stock market with an objective to earn higher returns. With the collapse of the stock market all the banks lost their investment which was actually the deposits made by their customers in the bank (Bernanke, 1983). Further, with the news of the crash of the stock market, many customers of the banks started withdrawing their deposits, due which most of the broking firms and banks become insolvent, further making the situation worse. It shambled the entire financial system of the country. Furthermore, some of the affluent stockholders, who became bankrupt, committed suicide. Even some of the banks and their owners who were not practicing the investment in the stock market had to pay the price since around 140 billion dollars of the customers of the banks disappeared and resulted in the failure of around ten thousand banks (Cooper, 1990).

THE STOCK MARKET CRASH OF 1929 AND THE GREAT DEPRESSION

Due to the crash of the stock market of the United Nation, its economy suffered a great loss and went into recession. The period of recession lasted for around a decade. During this period, the gross national product of the country was down by forty per cent and the unemployment rate jumped to twenty five per cent. The above stated factor that is, the crash of Dow Jones was the most important factor for the Great Depression, and there were other factors also that contributed to the Great Depression (Romer, 1992). Some of these are:

Unequal distribution of Income and Wealth

Although, throughout the country, wages of different labors were raised still the distribution of the income was unequal. Around 1890’s this gap widened up. The people who were at the top of the pyramid consisted of only 1 per cent of the total population but were having income six hundred and fifty per cent more than that of the 11 per cent of the people who were at the bottom of the pyramid. As, the majority of the income were in the hands of a few people, they lived their life lavishly and invested most of the income in the stock market. So any fluctuations in the stock market and the economy will shatter the entire economy. So, in 1929 when the market crashed, the US economy tumbled (McElvaine, 2010).

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Unequal distribution of Corporate Power

In the late 1870’s, most of the big corporate houses started acquiring smaller companies which resulted in the mergers and acquisitions and reduced competition in the US market. In the late 1920’s around fifty per cent of the corporate wealth was in America was with big corporate houses. Because of this concentration of corporate wealth, even only a few of the companies had to undergo the economic crash, the entire economy had to pay the price of the stock market collapse (Manikumar, 2003).

Inappropriate Banking Structure

In 1920’s, a lot of banks came into existence in the United Nations. The rate of opening of the new bank was four to five banks in a day. The main factor behind this was very limited restrictions put by the federal institute regarding the minimum capital requirement and maximum amount the banks can lend. Because of poor regulation, most of the banks soon become insolvent and started to close down their operations. In the period of around five years that is between 1923 and 1929, the rate of closing of banks in the United States was 2 banks a day. This also resulted in loss of money of many customers and contributed to the Great Depression (Berton, 2012).

Foreign Balance of Payment

After the world war, the United Nations was turned out to be a creditor nation rather than debtor nation. This was because it had money from both; victorious allies and the defeated central power. Moreover, most of the gold supply in the world was controlled by the United States by the end of 1920’s. If the nation is not able to pay in gold, there was option that it can pay in terms of goods and services, but protectionism and high tariffs, had a negative impact on the balance of payment of United States as some countries do not have enough money to purchase American goods and services and in addition, they were not able to pay their debts. Thus, its balance of payment was affected (Rothermund, 2002).

Poor State of Economic Intelligence

In the views of most of the political parties in America, there must be a self regulating and laissez faire economy. The businesses must try to encourage employment even if they have to hold on their productions. But, businesses did not able to implement this for long as they were not selling goods. Further, in order to balance the budgeted demand, the government decided not to deduct tax and not to increase government spending. But, it proved to be fatal in the situation where there was falling prices and a lot of unemployment (Bernstein and Bernstein, 1989).

Decrease in Money Supply

With the decrease in money supply in the economy, all the economic development activities were coming to halt between 1929 and 1933. Moreover, there was a decline in the nominal income and the production with the rise in the rate of unemployment. This could have been avoided if the Federal Reserve had increased the flow of activities so as to increase in the economic activities (Hoover, 1952).

International Factors

The impact of the Great depression was global. During that time the international monetary system was operating on the fixed rate system. Further the rules were so designed that slowdown in large economy will have any ill effects on all the economies of the world. Its repercussions will be further harmful for the origin country (Olson, 2001).

CONCLUSION

After working on the above paper, it can be concluded that the crash of the stock market, that is, Dow Jones in the year 1929 was the major reason behind the Great Depression. Because of the crash in the stock market, many people lost their lifetime savings and even it gave rise to unemployment and poverty. Most the companies and banks were also not able to sustain in such economic downfall situation and had to close their operations. Apart from the stock market crash, other factors which contributed to the Great Depression are improper banking system, decrease in money, unequal distribution of corporate power and wealth, etc.

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REFERENCES

  • Abbasi, M. Z. 2010. The Ascent of Money: A Financial History of the World. International Journal of Law and Management. 52(4). pp.332-335.
  • Bernanke, B. 1983. Nonmonetary effects of the financial crisis in the propagation of the Great Depression. American Economic Review. 73. pp.257-276.
  • Bernstein, M. A. and Bernstein, M. A. 1989. The Great Depression: Delayed Recovery and Economic Change in America, 1929-1939. Cambridge University Press.
  • Berton, P. 2012. The Great Depression: 1929-1939. Doubleday Canada.
  • Bye, D. J. 2010. Financial Times Historical Archive 1888-2006. Reference Reviews. 24(8). pp.8-9.
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