THE GREAT DEPRESSION AND THE N EW DEAL
The Great Depression was a period of severe economic hardship lasting from 1929 to World
War II. A combination of factors caused the Great Depression. Three of the most important causes were: 1)
Overspeculation in stocks using borrowed money that could not be repaid when the stock market crashed in
1929 and stock prices collapsed, 2) the Federal Reserve’s failure to prevent widespread collapse of the
nation’s banking system in the late 1920s and early 1930s, leading to severe contraction in the nation’s supply
of money in circulation, 3) High protective tariffs like the Hawley-Smoot Act (Tariff Act of 1930) that produced
retaliatory tariffs in other countries, which strangled world trade.
Speculation is the act of buying something at a low price in the hope of reselling it later at a profit. One
way people make money off stocks is through speculation. They buy them at one price. Then when the
stock’s price goes up, they sell their stock at a profit. Between 1920 and 1929 prices on the New York Stock
Exchange, the nation’s largest stock market, steadily increased. As a result, stock market speculators became
very wealthy. Many of them realized if they borrowed money, then they could buy even more stock. After
these investors sold their stock, they could repay their loans and still clear larger profits. This practice of
buying stock on credit was called buying stock on margin. Margin buying led to overspeculation in the stock
market. When the market dropped, investors who had bought stock on credit found themselves in a difficult
position. The terms of their loans allowed their creditors to demand enough money to cover the stock’s
original value. This forced investors to sell even more stock, which caused s tock prices to drop even further.
This downward cycle continued until the New York Stock Exchange crashed.
The Federal Reserve System functions as the central bank of the United States. The Federal Reserve
Act created the Federal Reserve Bank system in 1913. This law divided the United States into twelve Federal
Reserve districts, each of which possesses a Federal Reserve Bank. A Federal Reserve Bank is a banker’s bank.
Only banks can have accounts at a Federal Reserve Bank. If a bank needs to borrow money, it may do so from
the Federal Reserve Bank. However, a bank must pay interest on its loans from the Federal Reserve, just as
individuals must pay interest if they borrow money from a bank. The Federal Reserve Board, appointed by the
President of the United States, oversees the actions of the Federal Reserve Banks and sets the interest rate
which banks must pay to borrow money from the Fed. The Federal Reserve’s power to set interest rates
enables it to control the nation’s money supply. If the Federal Reserve Board believes the American economy
is slowing down, it will cut interest rates and thereby encourage borrowing. On the other hand, if the Federal
Reserve Board believes the economy is overheating and thereby causing inflation, then it wi ll raise interest
rates. (Inflation means prices increase, and the dollar buys less.)
When the stock market crashed in 1929, the Federal Reserve Board was unable to prevent it from
triggering the Great Depression. During the twenties, many banks had invested their savings deposits in the
stock market. They had also loaned money to speculators who were buying stock on credit. When the market
crashed, these individuals could not cover their loans. As a result, the banks lost the money, which they had
loaned for stock speculation. Although the Federal Reserve Board had recognized in the late twenties that
speculation was out of control and had tried to adjust interest rates accordingly, it could not protect individual
banks from their unsound loan policies. Once banks began to fail, Americans began to lose confidence in the
nation’s entire banking system. Thousands of Americans rushed to withdraw their savings from the banks,
before they closed. This action placed even more pressure on the nation’s banks. As a result, during the first
three years of the Great Depression, five thousand banks failed and nine million Americans lost their savings
accounts. The Federal Reserve’s failure to prevent widespread collapse of the nation’s banking system in the
late 1920s and early 1930s led to a severe contraction (reduction) in the nation’s supply of money in
circulation. High protective tariffs also helped cause the Great Depression. A protective tariff is a tax on
imports that is so high that Americans cannot afford to buy foreign goods. After the 1929 stock market crash,
Congress attempted to help American business by passing the Tariff Act of 1930, which was popularly called
the Hawley-Smoot Tariff. Since the Hawley-Smoot Tariff was a protective tariff that set the highest tariff rates
in American history, historians now believe it actually had the opposite effect from what Congress intended.
Instead of helping business by encouraging Americans to buy American-made goods, the Hawley-Smoot Tariff
encouraged foreign countries to retaliate by passing high tariffs of their own. This meant foreigners could not
afford to buy American goods. In short, the erection of tariff barriers by all of the world’s major industrial
powers strangled world trade. This decrease in world trade deepened the worldwide depression.
The Great Depression had a four-pronged effect on the United States. First, unemployment
skyrocketed and homelessness increased. By 1932 twelve million Americans were out of work, and the
unemployment rate stood at twenty-five percent of the American work force. Second, bank closings led to a
near collapse of the nation’s financial system. Third, business bankruptcies, increased unemployment, and
bank closings led to political unrest. Labor unions especially became more militant, and some even
questioned whether capitalism was the best economic system for the United States. Fourth, as the Great
Depression worsened banks foreclosed on thousands of farms. These farm foreclosures caused thousands of
farm families to migrate (move away) from the lands of their birth. They traveled in search of jobs, which
often did not exist. Most Americans blamed President Herbert Hoover, a Republican, for the terrible
conditions of the Great Depression. Consequently, in the presidential election of 1932 the Democrat
candidate Franklin Delano Roosevelt (FDR) overwhelmingly defeated President Hoover’s bid for re-election.
At his inauguration, Roosevelt tried to rally the American people by telling them, “This is pre-eminently the
time to speak the truth, the whole truth, frankly and boldly. Nor need we shrink from honestly facing
conditions in our country today. This great nation will endure as it has endured, will revive and will prosper.
So first of all let me assert by firm belief that the only thing we have to fear is fear itself.” President Roosevelt
offered a “New Deal” for the American people. The New Deal was FDR’s program to end the Great
Depression. This program changed the role of the government to a more active participant in solving the
nation’s problems. The power of the federal government increased, and Americans came to expect the
federal government to take responsibility for bringing prosperity to the American economy. The New Deal
followed a three-pronged strategy, often called the “three R’s.” These three R’s were relief, recovery and
Relief programs tried to ease the suffering of the unemployed. Relief measures, like the Works
Progress Administration (WPA), provided direct payments to people for immediate help. Many of these were
public works programs. Public works are construction projects that benefit the whole society, like highways,
bridges, schools, post offices, and parks. The federal government hired unemployed Ameri cans who could not
find jobs. Recovery programs aimed to bring about the recovery of business in all areas of the American
economy. They were designed to bring the nation out of depression over time. For example, the Agricultural
Adjustment Administration (AAA) tried to help farmers recover from the depression by limiting agricultural
production and thereby raising livestock and crop prices.
Reform programs attempted to bring about change for the better in American society.
Some reform programs tried to help prevent future economic crises, by correcting unsound banking and
investment practices. One program in this category was the Federal Deposit Insurance Corporation (FDIC),
which protects the money of depositors in insured banks. Other reform programs tried to provide a degree of
financial security for the most needy Americans. For example, the Social Security Act offered safeguards for
workers, including unemployment insurance and retirement benefits. Americans came to believe that
American society should use the federal government to provide care for those Americans, who through no
fault of their own could not take care of themselves.
Although the Great Depression did not end until World War II, the New Deal provided hope for millions
of Americans during one of the most difficult decades in American history. The New Deal also had lasting
results. It permanently changed the role of the American government in the economy. The New Deal also
fostered (encouraged) changes in people’s attitudes toward government’s responsibilities. Organized labor
acquired new rights, like the right to form a union, the right to strike, and minimum wage. Finally, the New
Deal set in place federal legislation that reshaped modern American capitalism.