What caused the great depression? What could have caused the booming 1920s to be followed with the worst economic disaster in US history? Here are the main causes of the great depression.
When most people talk about what caused the great depression, they tell you the same old story. Greed caused people to invest into the stock market and to borrow money, than when the stock market crashed investors pulled money out. This caused the market to collapse and destroyed the economy.
Most people are so eager to place the whole blame of the great depression on greed, which is not entirely true. Greed happens in the economy all the time, people work, they invest, and they do what they can to take advantage of their situation. Greed is always a factor and yet we are not always in a depression.
Placing all the blame on the depression on the greed of individuals means you are overlooking the back-story behind the event and pointing figures at an easy target.
It is similar to saying the Titanic sank because it is made of Iron and steel, and while yes the titanic was made of iron and steel and those elements do sink in water it wasn’t the reason it sank. Ships made out of iron and steel float all the time. Only when something major happens (like hitting an Ice Berg) do they sink.
In a similar way, only when something major happens to the economy does it change. The major shift that happened during this time was government regulation.
The great depression (similar to the 2008 financial crisis) really shows how regulation of the economy can hurt a marketplace. It all started way back in 1912 when the Democratic party took control of both the White House (Woodrow Wilson) and Congress.
At the time there was two viewpoints held on how the economy should be regulated.
The Republicans sided mainly with the Aldrich Plan, which put more power into the private sector and let banks regulate interest rates and Democrats who sided with The Federal Reserve System, which gave an independent entity the power to regulate interest rates, regulate the amount of money in the economy, and control inflation.
Since the Democrats had more political power at the time the Federal Reserve System passed in congress and was signed by Democratic president Woodrow Wilson. Thus the Federal Reserve was created on December, 23, 1913.
Originally the Federal Reserve lowered interest rates and as a result the economy saw an increase in borrowing. Investors and business owners who saw rising stock prices and low interest rates figured it was a no-brainer.
After all, if you could borrow money at 1% and put it into a market making 20% a year it simply made sense for people to borrow more money. This then lead to the roaring 20’s were the economy was good, businesses where thriving, and unemployment was low. But there was one problem.
All of the money flowing into the economy thanks to the Federal Reserve and their low interest rate created inflation. As incomes went up, so did the price of goods and business costs.
The economy was now dependent upon the inflow of money from the Federal Reserve and the low interest rates.
When the Fed increased interest rates in 1929 it would be one of the main causes of the great depression. As a result less loans were being created and less money was able to flow into the economy.
Some investors who saw this happening got out of the marketplace early, weakening the bullish market. As the markets stopped going up investors began to panic and sell their shares of stock. Overleveraged investors scared of losing their life savings sold their shares of stock and forced the market downward.
All this sparked the beginning of black Tuesday October 29, 1929 the day the stock market crashed.
After the crash Americans started spending less and started saving more. This lead to less production and less jobs, causing unemployment to go higher and higher.
Attempting to recover the US government passed a series of laws that ended up hurting the economy. One example was the Smoot Hawley Tariff, which set a high tax on foreign goods.
This ended up hurting the US economy even further. As the US raised taxes on foreign goods it hurt the economies in other countries that were selling things in the US. As a result other countries raised taxes US imports. US businesses where devastated as demand for their product in foreign countries shrunk and trade with other countries was greatly reduced. All of these things added up to hurt the economy even more, which is something they didn’t need to have happen to them during their time of crisis.
What Caused the Great Depression Bank Failures?
Another major influence was the massive bank failures happening across the country. As banks disappeared so did the money that was deposited in them. There was no such thing as insured by the government at that time. In other words ordinary citizens where losing their life savings left and right.
So why did banks fail? There are three major reasons.
1. The McFadden Act of 1927
This act limited the size a bank could grow by forcing banks to stay within the state which they originated in. Other countries like Canada which did not have this regulation fared much better. Compared to the 9,000 banks lost in America not a single Canadian bank went bankrupt.
The average man was unable to pay off his debts, so they simply borrowed more money causing more stress on the banks.
Panic steamed from the crash and forced people to pull their money out of banks. The panic only grew as more banks fell.
This 12 year period lasting from 1929 to 1941 was devastating to most Americans. We would not fully recover until the US entered WWII and started creating new jobs.
For a more detailed description of what caused the great depression here is a very informative video I found.