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Economics questions: What caused the GreatDepression? Could we have prevented it?


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#1 of 16 OFFLINE   Jonathan Burk

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Posted December 18 2002 - 06:34 AM

I've been doing a little history reading, and just finished a brief history of the Great Depression. As I finished, it occurred to me that while I know about the effects of the Depression (i.e. unemployment, lots of poor people, everyone going to see Shirley Temple movies), I don't know much about why we had a Great Depression. I also know Hoover didn't do much to try to stop it (he thought the market would correct itself), and Roosevelt did everything he could (New Deal, NRA etc.), but the Depression didn't end until we got into World War 2.

I found this website:

http://econ161.berke...ch_Crash14.html

but the economics are a little out of my reach.

Is there an easy way to describe the causes or the Great Depression, what happened exactly, and how we could have avoided it or recovered more quickly? Is there debate about these questions, or is there a consensus? Again, I'm just referring to the economic issues, and not the political, social or other aspects.

#2 of 16 OFFLINE   Mark Dubbelboer

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Posted December 18 2002 - 07:08 AM

wow, that link is very informative...maybe a bit too much for someone that's not taking that class however.
I think it would confuse most people in the class as well as it's a first year class.

regardless,
1. overspeculation in the stock market. the industrial average had raised some insane amount 8x or so in the last 8 years.
2. to counter this the federal reserve raised interest rates to prevent inflation associated with growth that large
3. businesses stopped producing because the cost of borrowing (interest rate) was too high
4. vicious cycle ensues

keep in mind that this is going from my memory of a paper i wrote a good four semesers ago. don't take it as the bible but it should be a decent explanation for a non-econ class.

mark

#3 of 16 OFFLINE   andrew markworthy

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Posted December 18 2002 - 07:46 AM

There is no simple answer to your question, alas.

In essence, the Great Depression began for several reasons, including:

(a) the government of Harding and then Hoover thought that the economy should be left to run itself. Minimal intervention meant that folks could do largely what they wanted. And therein lay the problem: people began to invest heavily in the stock market on credit. Millions of small time investors started investing in stock with often only the capacity to pay 10 per cent of its worth up front. The trouble was that everybody was buying stock in a buying frenzy, and stock values got hiked up way beyond their true worth. When the cold truth hit everyone (i.e. that their stock was grossly over-valued) there was a mass panic, and people sold their stock. On Black Tuesday, the market in effect collapsed. Arguably, had better regulations been in place in the first instance, this would never have happened. Big institutions did what they could by buying up stock en masse, but it was no good. The simple truth is that the investment frenzy should never have been allowed to happen in the first place.

(b) The world market after World War I was not very bouyant. Britain (which don't forget, was world leader pre-1914) was fatally weakened by the spending on WWI (not helped by the USA's insistance that the UK repay its war loans in full). Europe was in a worse state. Germany had been a major player, but now was permanently bankrupt. This was in no small part due to the punitive (and indeed vindictive) measures put in the Versailles Treaty at the insistance of France and the USA, which in effect prevented Germany regaining any sort of economic stability. So how did this affect the USA? Well, quite simply, there wasn't the market for American goods. Thus, when the USA market collapsed, the rest of the world was in no position to prop America up.

© Alongside the great crash, the USA also suffered from the dustbowls that wrecked American agriculture. Thus, the whole economy suffered a severe jolt. Again, the US government could have done more to prevent the collapse happening in the first place.

(d) The early political reaction to this was pretty much laissez-faire. How beneficial Roosevelt's measures were is open to debate (since it wasn't until WWII that there was full employment again - and the same went for the UK), but they were arguably better than sitting on one's hands.

Hope this is of use!

#4 of 16 OFFLINE   Philip_G

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Posted December 18 2002 - 08:18 AM

I would add to andrew's list a lot of people were buying stock on margin and couldn't handle the losses with very little of their own $ invested but a lot lost.
then people lost faith in banks, so there was less money to be lent and it sort of snowballed, or so I remember Posted Image it's been awhile since history..

#5 of 16 OFFLINE   Ashley Seymour

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Posted December 18 2002 - 09:37 AM

1. overspeculation in the stock market. the industrial average had raised some insane amount 8x or so in the last 8 years. 2. to counter this the federal reserve raised interest rates to prevent inflation associated with growth that large 3. businesses stopped producing because the cost of borrowing (interest rate) was too high 4. vicious cycle ensues

(d) The early political reaction to this was pretty much laissez-faire. How beneficial Roosevelt's measures were is open to debate (since it wasn't until WWII that there was full employment again - and the same went for the UK), but they were arguably better than sitting on one's hands.

The second comment tends to countradict the first. If there was a laissez-fiare attitude, then why was the Federal Reserve so concerned with raising rates to head off inflation? The real problem in the early 30's was deflation and a lack of spending and investment by the public and business. Some historians are now critical that the Fed, far from sitting back and doing nothing actually did worse. Their policy was what turned a recession into the great depression. Roosevelt had to do something and to his credit he did the most with what he had. One of the problems is that almost as a knee jerk reaction, the public looks to government to pump up spending to ward off a recession.

It makes me a little nervous to consider where we are today. The greatest stock market boom in history ended in March 2000, just as did the boom of the roaring 20's in 1929. PE ratios in each era reached historic highs. In the late 90's they were around 26 and are still in the 20's. Historic PE's are around 12. If earnings continued at the present rate of growth we would expect a flat stock market for the next 10-13 years! The U.S. economy is in a recession with 6% unemployment. The FED had stated that it's primary concern is to avoid deflation. They are likely to go even lower than the near historic low interest rates. What happens when rates start to scrape near 0%? The FED will target longer term bonds and resort to Keynsian spending policies to do all possible to prevent deflation and a depression from occuring. The Japanese economy is sick and their central bank got rates down to 0% and still were not successfull. Our FED is really spooked right now and fear we may be heading in the same direction.
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#6 of 16 OFFLINE   Philip_G

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Posted December 18 2002 - 09:48 AM

it depends on what happens. The problem is when people hoard money, not directly the performance of the market.

The Fed took several actions that, in retrospect, were quite bad. The first thing it did was to inflate the money supply by about 60% during the 1920's. If the Fed had been a little more careful in expanding the money supply, it might have prevented the artificial Stock market boom and subsequent crash. Second, there are indications that the economy was starting to cool off on its own in early 1929, thus making the interest rate hike in TBD completely unnecessary and avoiding the subsequentcrash. The third mistake the Fed made was in early 1931. The Fed raised interest rates, exactly the wrong thing to do during a contraction. Ironically, the country's gold stock was increasing at this point all on its own, so doing nothing would have increased the money supply and helped the recovery.

#7 of 16 OFFLINE   Allen Hirsch

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Posted December 18 2002 - 09:50 AM

The big difference between Japan's situation in the '90s and ours today:
they still have a "sick" banking system - Japan never really took their medicine after their bubble burst, so banks STILL haven't been forced to write off bad loans, consolidate, or go out of business - which has greatly reduced the ability of the government's monetary and interest rate policy to jump-start their economy.

There were three main causes to the Great Depression:
1) stock market over-speculation - when it crashed, people went broke, and those who didn't lost confidence in the economy
2) monetary policy that exacerbated the economic effect of the stock market crash and led to deflation
3) increased tariffs, (Smoot-Hawley Bill) which decreased world trade (reducing demand for goods).

Deflationary economies are tricky things, since the consumer has no incentive to buy stuff today (it will be cheaper to buy tomorrow) and no incentive to borrow (it will be more expensive to re-pay with tomorrow's dollars). In many ways, our economic system NEEDS a small amount of inflation for everything to "work" - it creates the incentive to borrow and buy now, not later.
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#8 of 16 OFFLINE   Ashley Seymour

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Posted December 18 2002 - 11:00 AM

Allen's points are all very goodand I pretty much agree.

Harry Dent wrote a book in 1992 titled The Great Boom Ahead. He wrote that the remainder of the decade of the 90's would see the greatest economy in the history of the world. He predicted the stock market to boom. He said it didn't matter who would be elected president in 92 or 96, that the great cadre of baby boomers would be entering their peak spending years. He did research to show that at age 46 we would as a group spend more than at any other age, and that as we reach 50 our spending starts to drop off significantly. Boomers born between 1946 and 1960 would fuel this great economic expansion.

Dent gave as a reason for the Great Depression, restrictive immigration policies put in place at the end of the 19th century. The huge imigrant influx during the 1800's contributed to our economic expansion.

He followed up in 1998 with The Roaring 2,000's where he predicted a strong stock market in the fall on 1998, but a retrenchment in 2000 which was an election year. He revised upward his prediction of where the Dow and S&P 500 would go and gave figures between 21,000 and 35,000 for the DOW. After 2006-8 he expected the beginning of a Depression that would last until the 2020's because the baby boom was over and the cadre of young reaching their mid 40's would be significantly lower than totals in the 90's. He never mentioned it, but it is easy to see that the 70's saw a decade long recession and high inflation because the mid 40's cadre were born during the 30's in the depths of the Depression when the birth rate was low and immigration also low.

It looks like his forecase for the stock market will not make it by 2008-2010. The next issue is, will the economy muddle through for 6-8 years only to really start a depression? Figures, just in time for me to retire.

Sorry for throwing out a couple of esoteric theories to further muddy the cause of the Great Depression.
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#9 of 16 OFFLINE   Stephanie T.

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Posted December 18 2002 - 02:14 PM

Ahem. That was the Smoot-Hawley Tariff, and it was a significant, though not exceptional, factor in restricting world trade, as strongly protectionist measures were in place in many of the world's leading economies at that time. IIRC.

Another factor was the lack of effective regulation of the banking system -- which was just as overleveraged in the stock market as millions of individual speculators were -- coupled with the absence of federal protection of savings in those institutions. That had the effect of amplifying any public uncertainty about a given bank into a run on that bank -- an epidemic of fear and anxiety that spread like a wildfire across the country, again and again.

I may be wrong, but I believe that the relatively small size of the public, military, and higher education sectors in the pre-war economy was also a factor. Even before the Great Depression struck, the U.S. was predominantly a working-class (and the rural equivalent) society, and only marginally more urban than rural; the rise of the truly secure and educated urban/suburban middle classes as the demographic majority would not occur until after WWII, due in large part to the equalizing effects of the G.I. Bill and to increased spending on public schools and state universities.

And call me a starry-eyed liberal, but the (again, relative to today) lack of socio-economic equality and freedom experienced then by tens of millions of Americans helped undermine the nation's economic vitality, and made the U.S. more vulnerable to the downturns in its violent economic cycles. I'm referring in particular to the obstacles faced by African-Americans under Jim Crow, women under patriarchy, certain immigrant and religious groups who faced widespread discrimination, and the many who were born into poverty who had scant opportunity to get a decent education.

It's a modern truism of the right wing that political and economic freedom are often causatively linked, so that it's difficult to (perversely) engineer a society with one but not the other, even if one tried to do so. Yet, during the period between the wars, American laws, customs, and mores failed to adequately accomodate the talents and ambitions (entrepreneurial and otherwise) of millions of its citizens. A diffused, difficult-to-quantify, and macro-economic factor, perhaps, but a real one, nonetheless.

#10 of 16 OFFLINE   Ashley Seymour

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Posted December 18 2002 - 03:02 PM

Another factor was the lack of effective regulation of the banking system coupled with the absence of federal protection of savings in those institutions

There had been recessions and bank panics from the 1700's through to the end of the 19th century. Some were severe and had major impacts on our country at that time. The Great Depression was the most severe and far reaching. The banking system was under regulation at the time and it had been suggested that the Depression was the failure of the FED to understand the effect it was having on the economy. Deposit Insurance helped eliminate the run on banks that was a common part of American society in prior recessions. But even this protection did not come without cost as the savings and loan scandal of the 80's can attest.

A Depression was probably part of the cost we had to pay to gain a better understand of how complex financial societies behave. Before we were on a gold standard, and the Depression ended that.

As I mentioned, we are facing a real test over the next generation of whether there will be a new depression, or because of our knowledge and experience will it be mitigated.
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#11 of 16 OFFLINE   andrew markworthy

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Posted December 19 2002 - 07:37 AM

Quote:
The second comment tends to countradict the first. If there was a laissez-fiare attitude, then why was the Federal Reserve so concerned with raising rates to head off inflation? The real problem in the early 30's was deflation and a lack of spending and investment by the public and business.


With respect, they don't contradict all that much. Raising or lowering interest rates is something that has to happen in even the most easy-going of economies, and isn't as interventionist by any means as e.g. making sure that people don't over-stretch their credit by introducing regulations. And the problem with deflation occurred *after* the crash.

Incidentally, depressions are a cylical inevitability according to most theorists. If anyone is really interested in some good improving reading over the holiday season, try 'The Great Wave' by David Hackett Fischer.

#12 of 16 OFFLINE   Ashley Seymour

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Posted December 19 2002 - 08:38 AM

With respect, they don't contradict all that much. Raising or lowering interest rates is something that has to happen in even the most easy-going of economies, and isn't as interventionist by any means as e.g. making sure that people don't over-stretch their credit by introducing regulations.

The fact that there is a FED at all is anti laissez-faire so whatever action the FED takes, even if none at all, is interventionist.

About the only way that consumer credit is regulated is by audit policies and procedures in place regarding debt ratios and the amount of bad debt held by banks. Bad debts must be promptly recognized and charged off. The criticism raised above about the the inability of the Japanese banking system to have an effect on the recession makes a valid point when it is mentioned that bad debt has not been charged off.

Raising or lowering interest rates is by far one of the most interventionist actions taken by our or any government. It is no where as benign or neutral as many people believe. The attempts to insulate the FED from political influence aside, there is tremendous pressure on the FED at all times to take action to meet the agends of whatever party is in power. It really doesn't matter too much which one it is. Our country has been fortunate that the mistakes the FED makes have not been destructive; with the exception of what they did during the Depression.

The FED will raise or lower interest rates in an attempt to influence the increase or decreast of the money supply. Their action is not the direct mechanism by which money is created or destoryed, or by what rate it changes. Congress and the President may want to increase spending to help get us out of a recession, or may be blamed for too much spending that got us into one, but this action pales compared to the effect and power of the FED.

The most powerful man in our country is the President. The second most powerful is the FED Chairman.

And the problem with deflation occurred *after* the crash.

The crash is usually referred to the period in 1929 when the stock market went down or crashed. The real depression in this country didn't start till later in 30 and 31 and was severe for several years. Deflation was concurrent with and is aruged as the cause of the Depression.

You have piqued my interest with the book by Fisher.


Andrew, hope you don't mind my point/counterpoint. I love to debate and always learn something. I hope this lets Jonathan know that issues abound the Great Depression are still hotly debated.
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#13 of 16 OFFLINE   andrew markworthy

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Posted December 19 2002 - 09:38 PM

Ashley - no problem! I think to some extent we're in agreement - it's the terms we're using that cause the problem! I think it depends how we define 'laissez-faire'. Even Adam Smith (who started off the whole laissez-faire thing by arguing against protectionist tariffs, etc) wasn't in favour of a totally unrestricted market - it was acknowledged that *some* intervention/control was necessary. I think it's a matter of interpretation of terms.

As my old history master once said - 'history without debate is dead history and not worth studying'. However, I think we can agree that the causes of the Depression were complex! I think American historians tend to see it very much as due to internal forces, whilst non-Americans tend to see it as part of a global phenomenon. Having said that, in the UK the depression was much more regionalised. The south of England was *relatively* unaffected by the depression, and towns reliant on the new industries such as chemical engineering, were largely unaffected. It was the areas dependent on heavy industry and mining that showed the most severe effects. It's often been said that the best time to be middle class in Britain was during the 1920s and 30s (the heyday of the Jeeves and Wooster and Poirot stories, to try to put it into perspective).

#14 of 16 OFFLINE   Ashley Seymour

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Posted December 20 2002 - 06:06 AM

However, I think we can agree that the causes of the Depression were complex!

I agree and want to be careful not to convey the image that I believe that the deflation was the only cause of the Depression. I do feel that the deflation was the most signifcant cause, but plenty of other negatives transpired to contribute to the situation.

I also have read that the worst depression was in the US and that we exported a good bit of it to other countries.

We seem to keep patting ourselves on the back and feel we have solved and understand the mysteries of recessions. But they continue to return. We may not be able to prevent them, but we should keep l earning more so as to not exacerbate them.

Even Adam Smith (who started off the whole laissez-faire thing by arguing against protectionist tariffs, etc) wasn't in favour of a totally unrestricted market - it was acknowledged that *some* intervention/control was necessary.

Our government in the 80's missed one rather basic point. In an attempt to be less regulatory on the banks and savings and loan industies failed to also cut the guarantee of depositors funds. Once lenders found they could acquire high risk assets but be guaranteed that their liabilities were covered, it didn't take long for them to figure out how to bilk the system - witness the savings and loan scandal. Of course there would have been no support for removing deposit insurance, so the deregulation of the lending side should have been rethought.
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#15 of 16 OFFLINE   Trace Downing

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Posted December 20 2002 - 06:45 AM

One more take is more political than financial, although generally economics is political an that it affects nations, and how they are governed. One theory is that the concept of laissez fare, and other social darwinist theories favoring aristocracy is what causes collapses of empires, such as Britain after WWI

I finished Wealth and Democracy by Kevin Phillips last summer, and found it an easy read, but he throws a lot of stats, and concepts at you, so it might take a while to absorb, but it's well worth the read.

http://www.amazon.co....books&n=507846

#16 of 16 OFFLINE   Grant B

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Posted December 20 2002 - 09:47 AM

Amazing discussion considering this is primarily a HT Board.
I am not much of a economics fan, it's always put me off; but I am fairly knowledgeable on History. I seem to find a considerable amount of parallels between that period and now. Anyone else feel that way?


Quote:
Incidentally, depressions are a cylical inevitability according to most theorists.


Seems like there is something fundamentally wrong with a system that breaks down like clockwork. It really makes me wonder, we think we are so advanced but yet we accept economic depressions ( and the human devastation they bring) like they are as inevitable as the sun rising.
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