The Great Depression was a severe depression in the twentieth century, affecting the whole world. Although not all countries experienced its severity, the US was the hardest hit as it originated here with the collapse of the stock market. The depression then spread to every country rich and poor with devastating effect to personal income, tax and profits. The great depression led to the decline in output, rise of unemployment and deflation. The decline of the US economy was attributed to be the factor that affected other countries, but the conditions were made worse or better by the internal strength and weaknesses. The depression was thought to be as a result of stock market collapse of the 1929, but economists argue that it was the economic downturn that took hold in1929. The collapse of the stock market was which that led to fall of half of the US 25000 banks.
The use of the gold standard linked all countries to this network of exchange rate. It was the key player in transmitting the US downturn to other countries. The abandonment of using the gold standard led to recovery by the ensuing of monetary expansion. Thus, the great depression resulted to adaptation of fundamental changes in the economic theories, institutions and policies.
Causes of the Great Depression
a) Debt deflation
The level of debt of the US had reached a level of under 300% at the time of the depression which attributed to the dominant industrial expansions after the World War I, and the volume of new capital was increasing at a rate of 7.7%, while the standard index bonds yielded 4.9% (Romer). During the crash of the great depression, the margin requirement was 10%, and the brokerage firm issued $9 for every $1 had been invested. The fall of the market saw brokers recalling the loan which could not be paid back. This led to banks failure as debtor defaulted on debts with depositors withdrawing in mass, thus triggering banks to fall.
The government policies were ineffective leading to loss of billions in assets (Romer). Thus, the outstanding debt increased as the prices fell while the debt remained at the same amount. The capital investment and construction slowed as a result of poor profits, and the surviving banks were conservative in lending. This led to accumulation of capital reserves with fewer loans that intensified deflationary pressure, hence creating a vicious cycle. The fall of prices caused by debt was far ahead that the debt liquidation could not cope. This increased the value of dollar owed relative to the diminishing assets holding, and individuals’ efforts of paying their debt were effectively increasing it rather than reducing it.
b) Wealth and Income Disparities
The unequal distribution of wealth through the 1920s resulted in the great depression as the economy was producing more than it was able to consume. The low increase in wage than the productivity increase led to conversion of these benefits to profits which were invested in stock markets rather than consumer purchasing power (Romer). The increased production led to flourishing of the economy, and the Federal Reserve kept discount rate low which encouraged investment. The capital investment had created more in 1920s, than they could be profitably utilized thus, producing more than the purchasing power of consumers. This case brings out the cause of the great depression as the global overinvestment of heavy industrial capacities than independent businesses (Romer). The redistribution of consumer’s purchasing power was the solution so as to maintain the industries, and the inflationary increase of the purchasing power for consumers to spend.
c) The Structure of Financial Institutions
The structural weakness of the banks in a rural area was much vulnerable, as these banks relied on farmers. The fall of agricultural produce to farmers in debt led to the significant increase of interests rates on loans. The land had been over-mortgaged due to the earlier economic boom, and the low prices of output, made the farmers unable to service the loan defaulting as a result of high interest rates (Romer). This led to the fall of the small banks that relied on farmers. The large banks also failed for failure to maintain reserves that were adequate, and instead they invested heavily in stock markets and risky loans. Thus, the recession shock was high and the banks were unable to absorb due to their ill preparedness.
d) Gold Standard
The use of the gold standard had many consequences as countries used gold standards a means of currency rates and most nations were looking on ways to recover their lent quantity in the same value of gold. Countries had to set their currencies in terms of gold defending the price. The gold standards played a role by limiting the monetary policy in the US, as the standards saw the trade imbalances that led to the inflow of gold to the US (Romer).
Britain created currency control and restriction to its exchange, setting new prices for its currency, which was criticized, as to be forcing the revolution of wages without the tendency to equilibrium. The impact of deflation was hard to economies that relied on loons in financing their activities, as it erodes commodities prices increasing the actual value of debt. Gold standard thus, contributed to magnification of the shock and hindered any action in mitigating the increasing depression, transmitting the problem to the rest of the word. The gold standard required to maintain a high rate to attract investors, and thus inhibited the policy maker from loosening the monetary and fiscal policies. The fixing of gold standards ensured that international exchange only equilibrate through the interest rate. Countries that had abandoned the gold standards earlier suffered less and were quick to recover.
e) Collapse of International trade
The end of the World War I saw allies of the US being heavily indebted to US banks, and thus they sort for reparation from German, who was under economic hardship and could not afford to pay. These debtors pressured US to lessen them but refused with its banks loaning large amounts to European countries. The weakening of the US economy so many countries unable to borrow and the high tariffs made their goods difficult to sell; they started to default as there was no other means to repay their loans (Romer). The productivity of industries in Europe led to the decline in demand of US goods, and because of financial crises the affordability of foreign goods was difficult. This led to the destabilization of the west’s economy as a result of international debts. The high tariffs hindered the servicing of debts resulting to the payment of the debt only by reparation.
Protectionism also indicated the cause of the great depression as it yielded countries to be beggars this policies adopted by countries using the gold standard rather than exchange rate floating, could not cut the interest rate or lend as they could deplete their gold stocks. Thus, protectionism changed the terms of trade for countries that were restrained by the gold standards.
f) Dynamics in Population
The decrease in population led to the decline in demand of housing as a result of reduced immigration and the World War I deaths. The enactment of the 1924 immigration act saw the decline in the number of immigrants in the US (Romer). This was a contributing factor as resultant was the formation of fewer families, and this had an adverse effect on the demand of housing and other consumer goods. Thus, the propensity of economic growth is dependent of the population size.
Reasons for Prolonged Depression
The New Deal policies are said to slow the recovery of the great depression as some of them benefited the economy by the establishment of social safety, and the financial systems stabilization. However, other deals were responsible for the violation of the basic principles of economics, as they were suppressing the principle of competition, and setting of prices and wages that were beyond the normal level in quite a number of sectors. These policies plunged the economy back to depression as they were the stumbling block to the powerful recovery forces (Sullivan).
The excessive competition had been attributed to price and wages reduction led to the introduction of wages that were above to where they ought to be, which ran contrary to what would have been in an economic state resulting to gains in productivity. This led to the inability of consumers to purchase stalling demand decline in the national Gross National Product (Sullivan). The policies contained in the National Industrial Recovery Act (NIRA) exempted industries from antitrust prosecution by agreeing to enter into collective bargaining agreements that saw the rise in wages, but it ensured higher prices for goods. This saw more industries accounting 80 private and non-agricultural employments. It is contented that the policies prolonged the depression as the act was later declared to be against the law. The policies are said to have been short live d as they artificially inflated the wages. The NIRA policies were the most damaging as I had permitted the collusion of industries to increase wages and prices above the productivity growth.