Causes of the Current Economic Meltdown - Term Paper Example

Download file to see previous pages Economic recessions are a result of a decline in GDP growth, which is itself caused by a slowdown in manufacturing orders, falling housing prices and sales, and a drop-off in business investment. But the fundamental question is- what causes the slowdown in the first place? While few predicted the financial catastrophe, almost everyone has an explanation as to why it happened. Although it is important to note that recessions are a result of different factors as each has its own specific causes, all of them are usually preceded by a period of irrational exuberance. Before we look at the causes of the recent economic recession, it would be logical to first of all look at some of the reasons that led to the Great Depression, if for anything, see if some of the causes recur. Stock Market Crash In the 1920s, the economy was developing at a very high rate due to the birth of many businesses and companies. As a result, there was an increased supply of money and individuals invested their surplus in the stock market. On September 3, 1929, the stock market peaked, closing at a record of 381.17. Trading volume was 444,000 shares. At the end of the same month, the market closed at 343- a 10% decline. On Monday, October 29, 16.4% shares traded and the markets fell by an 11.5% margin. The markets closed at 230.17 by that time, down 40% from its all-time high. Reports indicate that in a single day investors lost 14 billion dollars and by the end of 1929, 40 billion dollars was lost. This crash put a lot of pressure on banks and caused a lot of money to be taken out of the economy. The stock market bubble finally burst on October 24, 1929, as investors began dumping shares en masse. On a day referred to as “Black Thursday”, a record 12.9 million shares were traded that day and five days later, on "Black Tuesday" 16 million shares were traded. This was after another wave of panic swept Wall Street. Millions of shares were rendered worthless, and those investors who had borrowed money to buy stocks were wiped out completely. Federal Reserve’s Role during the Great Depression In most cases, a recession is a result of inflation but in this case, it was caused by deflation. Cycles of ups and downs in the economy are normal. One of the reasons strongly touted as being the cause of the Great Depression was the increase in interest rates by the government. The rates increased, from 3.5% in 1929 to 5%. Upon increasing the rates, the government failed to act to stabilize or increase the money supply. In fact, between 1929 and 1933, the supply of money fell by 30%. This led to deflation. Bank Failures At the time there was a lot of fear that banks would collapse since there were no guarantees on cash at the bank. As more and more people panicked, there was a massive run to the banks to pull money out and some banks were not able to fulfill the requests for withdrawal and closed their doors. As banks collapsed, very many people lost their money. More panic followed as people lost their money and banks collapsed. This rush to withdraw money created a domino effect. There was no confidence in the banks and people resorted to keeping their money under their mattresses. Reports indicate that during that period, over 9,000 banks failed. Insurance policies were not as advanced as to cover deposits and thus as banks failed people simply lost their savings. ...Download file to see next pagesRead More