The Great Depression: Causes - Essay Example

Inserts His/her Inserts Inserts Grade (15, 04, The Great Depression: Causes Introduction World economy developed greatly in the 20th century. There are many great changes that occurred in 20th century and all these changes had a great impact on the field of economics. The Great Depression of 1929 is one of those events that changed the shape of modern economics forever. It all started in 1929 and the world trade shrank by more than 50 percent. The great depression is known as the worst economic decline in modern economics history. Employment decreased greatly all over the world and poverty reached new levels. After the great depression new methods of government intervention were introduced and world organizations like International Monetary Fund (IMF) were founded. The causes of this economic disaster are many and they will be the topic of discussion of this essay. These causes will help us understand why the great depression lasted for such a long time and why it could not be stopped even after government intervention. The main reasons of the great depression of 1929 are the stock market crash, the default of Banks, decrease in international demand and decrease in international trade. All these factors caused the world economy to stay in depression for such a long period. Causes of Depression In this section some major issues will be discussed which eventually led to great depression of 1929. Stock Market Crash of 1929 Great depression is market by a stock market crash in October 1929. It is probably the most widely known cause of the great depression. Stock prices plummeted on 29th October and people lost a great amount of money. In order to understand this particular cause we will have to look at the background of the stock market in 1920’s. There is no doubt that 1920’s was a great time for investors in the New York stock market. They were earnings high returns on their investment so many people started to invest money in the stocks (Walton & Rockoff, 2009). Due to highly unregulated stock markets it was very easy for investors and speculators to trade stocks. Initially dividend given by the companies was also high and this was another reason why long term investors wanted to invest money in the stock markets instead of investing it elsewhere. With everyone investing in the stock market investment in other sectors was decreasing and this was the start of a problem. Prices of stocks were increasing put not the production capacity of the companies. Production base was not increasing with the same pace so the stocks were severely overpriced. Investors were bidding the prices of scrip up but this was not representative of the performance of the company. When investors realized this they started to pull their money out of the stock market and as a result the stock market crashed. People lost a huge amount of money as a result and in turn their consumption decreased. The decrease in demand affected the profits of the companies so they started to lay off employees which in turn further decreased the demand. In this way a vicious cycle started and unemployment reached new heights (in some countries more than 33% decrease in employment was seen). This is how stock market crash started an economic recession that led to the great depression. Increase in Import Tariffs The demand was decreasing rapidly so governments wanted to protect the domestic companies. As a result import tariffs were increased. This step was taken by governments to counter the effects of depression but it further worsened the economic health of the countries. International trade shrank rapidly and this caused great problems for economies all over the world. International trade was very beneficial for the economy of many countries. It was a source of revenue and also increased the employment opportunities. By restricting international trade governments dug their own grave. They thought that it will protect their domestic industries but instead it was the means through which the depression was transferred to other countries as well (Krugman, P. 2009). When one country imposed taxes in imports then the exports of another country were reduced. This meant that industries of the exporting countries suffered and workers were fired. This caused another chain reaction which affected many countries at once. International trade decreased by almost 50 percent (Frank & Bernanke, 2007) so one can imagine the extent of the damage done by protectionist policies. Margin Requirement In 1929 when stock market crashed the margin offered by the brokerage firms was around 90 percent. That means that margin requirement for investors was only 10 percent. Investors were to have $100 in order to trade with $1000. This also is one of the causes of the stock market crash because people were reckless in trading. Because investors were trading with borrowed money they bought and sold stocks in large quantity. When the crash happen everyone went and sold his or her stock now this caused a huge panic in the market because even a small investor had a relatively large number of stocks due to margin. This made the market plummet like anything. Also because margin was available it was a good investment to buy and sell shares. Margin attracted investors towards stock markets. This was a problem because this extra money should have gone in the production sector so production capacity of the country increased. This would have increased employment and gross domestic product of the country but this was not the case. Bank Failures This is another cause of depression. When stock market collapsed and aggregate demand started to decrease as a result of decrease in consumption. People started to default on bank loans. Especially farmers started to default because they were not able to export to other countries. Other small business owners also defaulted. This caused some banks to default and this increased the negative feelings about the economy (Living History Organization, 2008). A default of few banks caused people to take money out of the bank and as a result more banks defaulted. This is another cause of great depression. Why did the Great Depression Lasted this Long? In this section we will discuss why the depression lasted for about a decade and why governments were not able to control events. Adam Smith’s Invisible Hand In 1929 economist believe in the invisible hand of Adam Smith, that market will balance itself with supply and demand, and there is no need of government intervention. Because of this thinking government did not interfere in the economy much before the great depression. Stock markets were high unregulated and the margin requirements were ridiculously low. Even in such a time government was not prepared to intervene because they believed in the economic philosophy of Adam Smith. Government’s Attempt to decrease Competition Governments also tried to decrease competition and this was done in order to ensure that industries are revived. The intervention of government in this area was disastrous for everyone because it allowed companies to collude and enjoy extraordinary profits (Ohanian, L. 2009). This was done in hope that unemployment would decrease. Government also forced these monopolies to increase the wages in order to revive the economy by boosting consumption patterns. But this step went wrong because these monopolies started to set prices and collude. This actually hurt the economy and did not bring the desired effect. The problem was that wages were no in line with the production (Ohanian, L. 2009). This gave labor unions extra ordinary power but the people in general did not gain anything out of it. Instead they had to suffer a lot because of the high prices. Usually when unemployment is high prices and wages fall but due to the policies of Roosevelt government with high unemployment rate prices and wages were increasing (Sullivan, M. 2004). This is the main cause of the problem. The intervention of government came but it was not able to elicit the desired result. The problem was with the policies and their implementation. It was short sightedness of the government to think that the economy would revive just by increasing the wages. They thought that wage increase would start a chain which will eventually lead the economy out of depression. But by increasing wage they gave money in the hand of few people at the cost of high prices for many. This policy did not work because only a few workers were enjoying the higher wages but due to collusions normal people were bearing higher cost of goods due to increase in prices. This policy was only intact for a few years but still it caused great amount of damage because it introduced a culture of high wages and collusion that took many years to go away. This policy of government is the major cause that extended the period of great depression for many more years. Conclusion Great depression is the most important event in the history of world economics and is the center of attention macroeconomist all over the world. The major causes of great depression included stock markets crash of 1929, trading on margin, import tariffs and bank failures. Due to inadequate policies of the government and economic philosophy of Adam Smith the depression lasted for more than a decade. Works Cited Page Bank Failure. Living History Farm, 2008. Web. http://www.livinghistoryfarm.org/farminginthe30s/money_08.html Frank & Bernanke. Principles of Macroeconomics (3rd ed.). Boston: McGraw-Hill/Irwin, 2007. Print Krugman, P. Protectionism and the Great Depression, The New York Times, 2009. Web. http://krugman.blogs.nytimes.com/2009/11/30/protectionism-and-the-great-depression/ Ohanian, L. Why Did the Great Depression Last So Long? Forbes, 2009. Web. http://www.forbes.com/2009/04/30/1930s-labor-wages-business-ohanian.html Sullivan, M. FDR's policies prolonged Depression by 7 years, UCLA economists calculate, UCLA News Room, 2004. Web. http://newsroom.ucla.edu/portal/ucla/FDR-s-Policies-Prolonged-Depression-5409.aspx Walton & Rockoff. History of the American Economy. New York: South-Western, 2009. Print   Read More