Causes of the Great Depression - George Washington High School

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Causes of the Great Depression - George Washington High School Powered By Docstoc
					      Causes of
the Great Depression &
  Hoover’s Response

 IB History of the Americas
Terms found in these notes that would be good for
                making notecards
•   Stock market            •   Inflation/deflation
•   GDP                     •   Speculators
•   Black Tuesday           •   Buying on margin
•   Exports/imports         •   GNP
•   Overproduction          •   Conservative Economic Policy
•   Under-consumption       •   Volunteerism
•   Supply and demand       •   Hoovervilles
•   Laissez-faire           •   Smoot-Hawley Tariff
•   Federal Reserve Board   •    Revenue Act of 1932
•   Monetary Policy
•   Surplus
             GDP vs. GNP
• GDP is the market value of everything
  produced within a country;
  – Example: McDonald’s Cheeseburgers
    grilled in Illinois, Ohio, and Florida
• GNP is the value of what’s produced by
  a country’s residents, no matter where
  they live.
  – Example: McDonald’s Cheeseburgers
    grilled in Illinois, France, and Canada.
     Black Monday vs. Black
   Tuesday vs. Black Thursday
• Black Thursday: October 24, 1929
   – the start of the Wall Street Crash of 1929 at the New
     York Stock Exchange
   – the market lost 11% of its value at the opening bell
• Black Monday: October 28, 1929
   – Over the weekend, the events were covered by the
     newspapers across the United States.
   – The market lost 13% of its value
• Black Tuesday: October 29, 1929
   – The market lost 12% of its value
     Myths and Misconceptions
• Many people believe that the crash of the stock market was the
  cause of the Depression. Not so, it was only a symptom.

• Many people also believe that Herbert Hoover’s laissez-fair
  economic philosophy prevented the federal government from
  taking steps to prevent the crisis. Hoover was proactive in trying to
  ease the impact of the depression, it was too little, too late.

• Many people think that the Great Depression was the only major
  economic crisis in U.S. history. Nope, but it was the worst.

• Many people do not realize that the Depression was global and
  affected almost every capitalist economy on earth

• Some believe that FDR and the New Deal ended the Depression.
  Wrong again, WWII ended the Depression
                      The Facts
• In September of 1929 the U.S. economy began showing signs of
  contraction (decline from the growth of the 1920s)
• August 1929, recession begins, GDP falls and unemployment
• Automobile sales fall 30% in 1929.
• By 1929 farm incomes fall more than 50%
• September 1929 stock prices begin to fall, the market crash on
  Black Tuesday October 29th losing 90% of its value by 1932.
• By 1932 US GDP fell 30%
• 1929-1932 US factory production fell 46%
• 1929-1932 US wholesale prices fell 32%
• 1929-1932 US exports fell 70%
• 1929-1932 US unemployment will reach 25% (33% in some
US Unemployment 1910-1960

               Abstract of the US Department of Labor
US GDP 1910-1960

 Based on data from: Louis D. Johnston and Samuel H. Williamson, "What Was the U.S. GDP
US Farm Prices 1928-1932

                   US Bureau of Labor Statistics
US Industrial Production
                                 Banking Practices
                                  & Fed Policies

         Causes of the Great Depression

Stock Market                     Political Decisions
1. Over-production
• The “roaring twenties” was an era of great prosperity and
  economic growth.
• Average output per worker increased 32% in
  manufacturing and corporate profits rose 62%.
• The availability of so many consumer goods, such as
  electric appliances, radios and automobiles, offered to
  make life easier.
• Americans felt they deserved to reward themselves after
  the sacrifices of World War I. A return to normalcy.
• This led to a high demand for such goods,
  so companies began to produce more and more, in order
  to meet that demand.
• Mass advertising fed mass consumption to satisfy the
  needs of mass production.
• Wages for labor remained stagnant (mechanization of
  labor, suppression of union collective bargaining).
  Businesses were investing profits in the stock market and
  not in workers wages. So….
• The uneven distribution of wealth grows. 1922 1% of the
  population owns 36.7% of the nations wealth by 1929 it
  has grown to 44.2%
• Eventually business produced more than consumers could
  purchase. You can only own so many radios, cars, and
• August 1929 Recession begins, two months before the
  stock market crash. During this two month period,
  production fell 20%, wholesale prices at 7.5 %, and
  personal income fell 5%.
       Farm Overproduction
• In 1929, Agriculture still makes up half of the US economy
• During World War I, with European farms in ruin, the
  American farm was a prosperous business.
• Increased food production during World War I was an
  economic “boom” for many farmers, who borrowed money
  to enlarge and modernize their farms.
• The government had also subsidized farms during the
  war, paying high prices for wheat and grains.
• When the subsidies were cut, it became difficult for many
  farmers to pay their debts when commodity prices
  dropped to normal levels.
• Over production of consumer goods and
  agricultural goods means…
• Supply was greater than demand.
• A surplus of goods in the market begins
  to drive prices down.
• Declining prices means declining profits
• Declining profits means stock values
  (for corporations) begin to fall.
2. Banking & Money Policies
Consumer Credit
        • The uneven distribution of
          wealth didn’t stop the poor
          and middle class from
          wanting to possess luxury
          items, such as
          cars and radios…
        • But, wages were not
          keeping up with the
          prices …and that created
             Consumer Credit
• One solution was to let products be purchased on credit.
• The concept of “buying now and paying later”
  caught on quickly.
• By the end of the 1920s, 60% of the cars and 80% of the
  radios were bought on installment credit.
• Consumerism in the New Era saw a change in US buying
  behavior. Thrift, saving, and frugality were replaced with
  consumption, and keeping up with the Jones’
 The Federal Reserve Board
• The Federal Reserve Board was created by Congress in 1917 in
  response to the Banking Crisis of 1907.
• The Fed was created as the US central bank with two primary
   – 1) Regulate and inspect the nations commercial banks,
        by assuring banks had sufficient cash reserves
   – 2) Regulate the amount of money circulating in the
        economy. Known as Monetary Policy
• To stimulate growth the Fed increases money in circulation by
  lowering interest rates for member banks, and decrease in the
  amount of money banks are required to keep in reserve
          Fed Monetary Policy
• The Federal Reserve was suppose to serve as a
  protective “watchdog” of the nation’s economy.
• It had the power to set the interest rate for loans
  issued by banks.
• In the 1920’s, the Fed encouraged buying on credit by
  lowering interest rates (discount rate)
• Eventually so many people were buying on credit that
  inflation increased.
• By 1929 the Fed decided to slow the rapid
  growth by increasing interest rates.
• Raising interest rates means that it cost more to
  borrow and raises the price of existing debt.
• So, People borrowed less and purchased fewer
• They also started using available cash to pay off
  debt and therefore purchased fewer goods.
• Less demand = surplus goods = deflation =
  declining profits = declining stock prices = rising
              The Stock Market
• The Stock Market is seen as an indicator of the nation’s
• In reality it is only an index of the value of corporate stocks
  based primarily on the market demand for a particular
• As an investment the goal is to buy low and sell high.
• The value of stocks soared in the 1920’s as corporate
  profits rose, fueled by mass consumption. (Fueled by
• Once a rich man’s game, everyone was “in the market” in
  the 20’s
• Optimism was high, and speculation was rampant
Stock Market: Buying on Margin
• Buying on the margin means that you can purchase
  shares with a down payment.
• The Margin Requirement in 1926 was 10%. So a $100
  share of stock could be yours with only a $10 down
• Speculators expect the value of the stock to go up in price
  enough (at least 90% to break even) covering the
• Buying on the margin encouraged thousands of small
  time, new (inexperienced) investors to purchase stocks
• As long as corporations were selling goods and turning a
  profit stock prices rose and buying on the margin was
• As long as…
                Louis Armstrong
          "I'm In The Market For You”

            I'll have to see my broker
            Find out what he can do.
        'Cause I'm in the market for you.
           There won’t be any joker,
          With margin I'm all through.
      'Cause I want you outright it's true.
   You’re going up, up, up in my estimation,
I want a thousand shares of your caresses too,
        We'll count the hugs and kisses,
            When dividends are due,
        'Cause I'm in the market for you.
Stock Market: Banks & Margins
• In 1927 banks did two stupid, greedy things
   – 1) Banks began letting customers borrow money to buy
        stocks and used the customers stock holdings as
        collateral for the loan.
        They gave money to people with no money to gamble

   – 2) Banks started to use depositors money to speculate in the
        stock market. Normally banks pay you interest for savings.
        Then they loan it to businesses or families that were good
        risks to buy homes or start companies etc.
        Not speculate in the market!
• By 1929, banks had made billions of dollars in risky loans
  with little collateral to back them up if borrowers defaulted.
So what went wrong?
            Stock Market Crash
• Black Tuesday, October 29th 1929.
• The market bubble bursts with a panic sell off of 16 million
  shares of stock.
• Investors lose 26 billion dollars (312 billion in 2010 dollars)
• The crash was not a one day event, stocks falling in September.
  Wealthy investors stepped in a bought up shares at bargain
• Those who bought on margin, however, panicked.

• It is impossible to know exactly what caused the initial panic but
  the market crash exposed the other problems in the economy
  setting into motion a deep lack of confidence in the economy.
• Banks made risky loans to borrowers to
  buy stocks on the margin.
• Banks used depositors money to
  speculate in the market
• When panic shook the market, the
  banks were left holding the bag
• Oh my…
   4. Bad Fed Banking Policies
• With the loss of confidence in stocks, people began to
  lose confidence in the security of their money being held
  in banks.
• Customers raced to their banks to withdraw their savings.
  (bank run)
• Customers closed accounts and banks were left without
  cash reserves putting them on the brink of failure.
   4. Bad Fed Banking Policies
• In its regulatory role, the Federal Reserve was also
  established to prevent bank closings.
• It was suppose to serve as the lender of last resort to
  banks on the verge of collapsing.
• The Fed lowered the reserve requirement for banks, so
  the banks did not have the cash to cover customer
  withdrawals. And the Fed did not provide short term loans
  to banks to cover the loses.
• 1930 the Fed cuts interest rates from 6% to 4% in attempt
  to increase the money supply
• Banks started to close, increasing the panic.
• 1930, 60 banks fail every month, by 1933 over 9,000
  banks fail (40% of the 1929 total)
• The Fed fails to manage the bank and
  currency crisis.
• Depositors now hide their money at
  home and banks have no money to lend
• Banks close and large amounts of
  money disappear from the economy
• Less money = less consumption = less
• Businesses go bankrupt
• People get laid off
• Thus the economy begins an irreversible
  downward spiral.
• Banks close and large amounts of money
  disappear from the economy
• By 1931, GNP falls by 18%,
  unemployment reaches 16%(8 million)
4. Bad Political Decisions:
             Political Decisions
• The severity of the Depression could have been lessened
  if policy makers would have been open to new ideas
• Conservative economic policy
   – Laissez fair, let the market right itself without government
   – Balance the budget, do not spend more than collected in tax
• Prevailing belief that private charities, churches, state and
  local governments provide relief and assistance to the
  poor, not the Federal Government
   – Most of these were ill equipped to deal with the number of
     people in need
“The sole function of the
government is to bring about
a condition of affairs
favorable to the beneficial
development of private
     ~Herbert Hoover (1930)
   Hoover’s Political Decisions

• Hoover initiated several
  programs to help the economy
  recover but it was too little, too
• Hoover favored volunteerism, or
  cooperation between business
  and government over coercive
Hoover’s Political Decisions
              • He showed some pro-labor
                 – Asked business leaders to
                   hold wages steady even
                   though profits were falling
                 – Authorized repatriation for
                   50,000 Mexicans (and
                   Mexican-Americans) to ease
                   unemployment and cut the
                   relief rolls in California
Hoover’s Political Decisions
• Hoover promoted volunteerism to prop up failing banks.
• National Credit Corporation / Reconstruction Finance
  Corporation (RFC)
• 1931, Hoover urged the larger (East Coast) banks to
  provide low interest loans to struggling rural banks
• Large banks were unwilling to offer loans without holding
  the smaller banks’ most valuable collateral.
• RFC failed to help the smaller banks.
Hoover’s Political Decisions
              • Rising unemployment led to
                homeowners defaulting on
                mortgages and renters being
                evicted from apartments.
              • The homeless settled in
                shanty towns called
              • 1932, Federal Home Loan
                Bank Act, was passed to
                spur new home construction,
                and reduce foreclosures.
              • Foreclosures dropped briefly
                in late 1932.
Hoover’s Political Decisions
• The Revenue Act of 1932 Increase taxes on struggling
  corporations and the wealthy = more money in the federal
  treasury to fund aid without deficit spending (more on this
• Emergency Relief and Construction Act of 1932. Federal
  money funneled to states to start public works projects
  (roads, drainage, schools) to put people back to work
   – Problem, it is not that easy to spend large amounts of money
     quickly on shovel-ready projects
   – Federal money trickled into states as the problem of
     unemployment grew exponentially
       Hoover’s Three Biggest
• Signing the Smoot-Hawley Tariff
• Revenue Act of 1932
• Balancing the budget
      Hoover & Smoot-Hawley
• The Smoot-Hawley Tariff was signed (reluctantly) by
  Hoover in 1932: raised US taxes on over 20,000 imported
• Smoot-Hawley raised tariffs by 50%
• Congress believed the tariff would make imports too
  expensive and Americans would buy American goods,
  increasing demand
• European countries retaliated with their own tariffs and
  U.S. exports fell by almost 70%... Ouch America 
      Hoover & Smoot-Hawley
• The trade war cost American farmers 1/3 of their market
  causing agricultural prices to fall and putting more farmers
  into bankruptcy.
• Tariffs damaged an already shaky economy in Germany.
• Germany begins to default on reparations payments to
  England and France required by the Versailles Treaty
   – France and England fall behind in their payments on loans
     from U.S. banks (used to buy weapons during WWI)
   – Weakening large U.S. banks
                                    Smoot Hawley Tariff of 1930 and Trade Reform Act of 1934

Billions of Nominal Dollars

                              4                                                                 Exports
                              3                                                                 Imports

                                  1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940
           Revenue Act of 1932 &
           Balancing the Budget
• Concerned over growing deficits, Congress passes and Hoover
  signs the Revenue Act of 1932
• The act:
   – Raised business taxes from 12% to 13.75%
   – Raised taxes on every bracket
   – Lower income brackets increases from 1% to 4%
   – Raised taxes on the wealthy from 24% to 64%
• The problem with raising taxes is that it takes money out of the
• Business facing lower profits had to now pay more taxes. To cut
  cost they laid off workers
• Since nothing seemed to help the economy, Hoover and
  Congress decided to balance the Federal budget.
   – Cut spending
• This shrunk the money supply even more
• Hoover was not the laissez-fairie people
  thought he was…
• He supported government actions to
  ease the crisis
• It was not enough
• He fell back on conservative economic
  policy and tried to balance the budget
• Smoot-Hawley
• Ohhh….!!!
            Let’s Review
•   Overproduction
•   Stagnant wages
•   Federal monetary policy
•   Banking practices -
•   Stock market
•   Political decisions

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