Causes of the Great Depression - Coursework Example

Causes of The great Depression xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Name xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Course xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Instructor xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Date Causes of the Great Depression Introduction The great depression occurred in the 1930s, just a decade before World War II. It started in 1930 and lasted up the late 1930s and mid 1940s in some countries. The depression highlighted just how much the world economies were interrelated and how much they can decline. The immediate cause of the depression was the fall of stock prices in the United States which began in early September, 1929. Soon after, on October 29, 1929, the worldwide stock markets crashed. The effects were devastating. The day came to be known as the Black Tuesday. Barely two months after the crash, over $40 billion dollars was lost by stockholders in the stock markets. Profits fell, personal incomes reduced, unemployment levels rose and international trade plunged by over 50% (Hall & Ferguson, 1998) The debate over the causes of the depression is still rife. To start with, demand-driven theories such as institutional economists and Keynesian economics argue that the depression was as a result of over-investment and under-consumption. The other mainstream theory is monetarist. It purports that the depression was just a normal recession which worsened due to huge policy mistakes by the monetary authorities in charge. Lastly, heterodox arguments reject the Keynesian and monetarist explanations. These theories include the Austrian school theory, the Marxist theory and the productivity shock argument. Mainstream Theories 1. Keynesian Theory In General Theory of Interest and Money, John Keynes argued that the depression was as a result of low aggregate expenditure which resulted in low unemployment which fell below average. As such, the economy plunged into low levels and reached equilibrium characterized by high unemployment and low economic productivity. According to Keynes, the depression would have been averted if governments had run deficits in order to keep the people employed. This is because the private sector cannot invest enough resources to keep production at normal levels when the economy is performing poorly. Keynes postulated that governments should increase spending or cut taxes during the times of economic crisis in order to ensure unemployment does not rise and to help people maintain their spending levels. This was attempted by Roosevelt through farm and public works subsidies and significantly improved the economy (Allgoewer, 2002). 2. Monetarist Theory Monetarists such as Milton Friedman argued that the depression was caused by a fall in the supply of money. Between august 1929 and March 1933, money supply stocks fell by more than a third. This resulted in the great contraction of money supply. It led to a fall in prices, incomes and employment and was as a result of restricted money supply due to poor policies by the American Federal Reserve System and its failure to intervene. If the Federal Reserve had intervened by either providing loans to the banks or buying government bonds in order to increase liquidity, the other banks would not have collapsed and the supply of money would not have diminished as it did. With little money available, loans were scarce and investors stopped investing leading to a rise in unemployment and a fall in economic productivity. The Federal Reserve failed to intervene due to the regulations which required the currency it issued to be 40% backed by gold (Bernanke, p.7, 2000). 3. Debt Deflation A third theory which tries to explain the causes if the great depression suggests that it occurred as a result of debt inflation. This argument was advanced by Irving Fisher who argued that the depression was caused by debt deflation and over-indebtedness. Loose credit led to over-indebtedness which in turn fuelled asset bubbles and speculation. A chain of events unraveled starting with distress selling and debt liquidation. This culminated in money hoarding and a rise in deflation-adjusted interest rates and a fall in nominal interest rates. Banks failed when debtors defaulted on debts while depositors started withdrawing their deposits in large numbers thus triggering bank runs. Federal Reserve regulations and government guarantees failed totally while outstanding debts become heavier due to deflation. Borrowers could not repay back their loans and future prospects in investments appeared poor. Banks became more conservative in lending and this further accelerated the downward spiral (Allgoewer, 2002). 4. Breakdown of International Trade This also contributed to the great depression according to some economists. Under this argument, the sharp reduction in international trade from 1930 served to fuel the depression, especially for countries that were more reliant on international trade such as Germany and the United Kingdom, with the exception of the United States. The Smoot-Hawley tariff Act enacted by America in June 1930 is quoted as the main cause. It led to a reduction in international trade and forced other countries to enact harmful retaliatory tariffs. As a result, import duties rose from 25.9% on average in 1921-1925 to 50% on average in the period 1931-1935. In terms of trade, American exports fell catastrophically from around $5.2 billion in the year 1929 to about $1.7 in 1933. The agricultural sector was hurt most and this caused many farmers to default on their loans, further worsening the overall economic condition (Hall et al, 1998) Heterodox Theories These are other theories apart from the mainstream theories which try to explain the cause of the depression. They are: 1. The Austrian School Theory Proponents of this argument claim that the blame for the great depression lies with the Federal Reserve, just like monetarists. However, unlike the monetarists, they argue that the depression occurred as a result of an expansion of money supply which happened in the 1920s and resulted in an unsustainable boom that was driven by credit. This inflation led to a boom in prices of bonds and stocks as well as other capital goods and by the time the Federal Reserve intervened in 1928, an economic contraction was inevitably beckoning. They also argue that the government should not have intervened in 1929 as it only worsened matters as it delayed the market’s self adjustment (Cantor & Cox, 2009). 2. Marxist argument According to Karl max, under free market capitalism, both depression and recession are inevitable. This is due to the absence of restrictions on capital accumulation other than the market itself. As such, sometimes there is over-accumulation of capital and this leads to imbalances and at times, economic crises. These crises are unavoidable and become severe. For normality to reign there must be a total societal change engineered by class conflict (Cantor & Cox, 2009). 3. Productivity shock According to this argument, the early decades of the twentieth century witnessed unprecedented rise in economic output as a result of mass production, motorized farming and electrification. This resulted in excess production capacity which led to a fall in the prices of produce and closure of manufacturing plants. This meant people lost jobs and agriculture was no longer as profitable as in the past decades. Even non-agricultural firms had to lay down workers due to a fall in demand and prices. Another factor that contributed to a reduction in production is the replacement of horses in war by machinery which meant land which was being used to grow food for these animals was freed up after WW1 (Crafts, p.335, 2013). Why did the great depression have such severe consequences in Germany? Though the great depression emanated from the United States, its impact on foreign countries was immense. Among these foreign countries, Germany was one of those which were severely affected. Although it had attained stability in the time period from 1924-1928 after overcoming the severe inflation of 1922-1923, Germany was at crossroads again in 1929 after unemployment rose. To begin with, the New York stock market was booming in the mid 1920s and as a result, in 1928, American investors in Germany started pulling money out of Germany in order to invest in the stock exchange. Following the crash of the stock market in 1929, more of these investors withdrew their money out of Germany and the rest of the European economies. As a result, Germany banks, and indeed the entire economy, were weakened and this made it suffer severely from the depression (Duiker, p.87, 2010). Another reason why Germany suffered more than the other countries is because of the political and economic situation it was in. It was heavily relying on American loans to drive its economy and the moment the loans stopped, its economy inadvertently came into a standstill. Additionally, it was paying reparations to other countries following its defeat after World War I. this had drained its economy. It was relying on the countries it was repaying to drive its economy. Particularly, America’s protectionism put Weimar Republic in a precarious position because it could not export much of its products to the U.S. a combination of these factors meant Germany was already faced with economic danger in case of ripples throughout the world economy (Rothermund, 1996, p.35). Matters worsened after the crash of the New York stock market. The foreign credit which had helped drive the Germany economy towards recovery was no longer available. High tariffs reduced exports and short term loans got canceled. Rightist and leftist political movements became popular and radical (Burg, 2005, p.48). The elections of 1930 played a significant role that led Germany’s Weimar Republic to severely suffer from the great depression. The great depression which was by then taking toll on a majority of Germans pulled a majority of the working class to the left while those from other social classes were pulled towards the Nazis. This fragmentation turned into polarization. By 1932, Germany income had fallen by a whopping 39% while that of Britain and France had fallen by 15% and 16% respectively. In 1932, the government tried to lower the pressure on wages by maintaining a balanced budget and decreasing welfare spending. Its leader argued that Germany could no longer afford to pay reparations. The repayment of war reparations by Germany was suspended after the Lausanne conference. This had a deflationary effect. As a result, life became more unbearable which led to the popularity of the Nazis who won the election in the following year (Bernherd, 2005, p. 70-73). Hitler rose to power in the beginning of 1933 riding on the promise to help Germans get out of the economic instability which had been caused by the depression. On rising to power, he emphasized on policies aimed at making the economy self-sufficient and greatly reduced trade volumes with foreign countries. The policies seemed successful as unemployment gradually reduced to near-extinction by 1938, though unemployment statistics did not account for Jews and women. But Germany still suffered severely from the depression even at this time due to excessive government spending on rearmament. The rise in spending rates exceeded those of economic growth. As a result, less money was available to businesses for expansion and this plunged Germany into heavier debts. The deficit and national debt rose gradually to reach to 38 billion marks by 1939 which coincided with the outbreak of the war. Essentially, Germany suffered more than it should have due to allocation of most of the resources towards armament policies as opposed to economic projects. Although Adolf Hitler did not in any way contribute to the great depression, he used it to rise to power by exploiting a desperate population through the promise of a better economy. However, though many of his policies were effective in improving the German economy, others undermined it. He initially adopted the policies of the previous regime which aimed at combating the effects of the depression. These were mainly Keynesian and relied on huge public works supplemented by deficit spending. Unemployment reduced but exports and imports fell considerably as the depression wore on. The government then asserted its authority by enacting policies that were politically motivated. By 1936, industrialists were no longer involved in decision making. The state became more interventionist and focused more on the growth of the armament sector. This skewed approach meant Germany was left in a worse-off situation than it should have due to the great depression (Kershaw, p.50, 2000) Conclusion The great depression left an indelible mark in the history of the world economy. Up to these days, economies enact policies aimed at ensuring there is stability and continuity. The economic crisis of 2008 was another important lesson and luckily, a depression did not occur. To significantly reduce the risk of suffering from another depression, governments pursue policies aimed at restoring economic stability whenever the risk becomes evident. Common measures include public works and deficit spending (Cynamon, 2012, p.196-198).Though Germany suffered a lot from the great depression, the effect would have been less were it not for the situation the country was in at that time. Its reliant on foreign loans together with the reparations it was paying were responsible for the severity of the depression. Today, Germany is one of the most stable economies in Europe and was hardly affected by the crisis of 2008. This means she learnt her lesson and her economic policies are sound and effective. References Allgoewer, E. (2002). Underconsumption theories and Keynesian economics: interpretations of the great depression. St. Gallen: Forschungsgemeinschaft für Nationalökonomie an der Universität St. Gallen. Bernanke, B. (2000). Essays on the great depression. Princeton, N.J.: Princeton University Press. Bernhard, M. H. (2005). Weimar Germany. Institutions and the fate of democracy: Germany and Poland in the twentieth century (pp. 70-73). Pittsburgh: University of Pittsburgh Press. Burg, D. F. (2005). Fateful Year on Wall Street. The Great Depression (Updated ed., pp. 48-49). New York: Facts On File. Cantor, P. A., & Cox, S. (2009). Literature & the economics of liberty: spontaneous order in culture. Auburn, Ala.: Ludwig von Mises Institute. Crafts, N. F. (2013). Labor Markets in Recession and Recovery. The great depression of the 1930s: lessons for today (p. 335). Oxford: Oxford University Press. Cynamon, B. Z. (2012). Global Imbalances and U.S trade. After the great recession: the struggle for economic recovery and growth (pp. 196-198). Cambridge: Cambridge Univ. Press. Duiker, W. J. (2010). War and Revolution: World War I and its Aftermath. Contemporary world history (5th ed., p. 87). Boston: Wadsworth, Cengage Learning. Hall, T. E., & Ferguson, J. D. (1998). The Great Depression an international disaster of perverse economic policies. Ann Arbor: University of Michigan Press. Kershaw, I. (2000). The Nazi dictatorship: problems and perspectives of interpretation (4th ed.). London: Arnold ;. Rothermund, D. (1996). War Debts and Reparations. The global impact of the Great Depression, 1929-1939 (pp. 34-35). London: Routledge. Read More