Origins of the Great Depression in economics

Economics

The Great Depression

Origins and Solutions

Since its earliest days, capitalism has been plagued by cycles of boom and bust. Nineteenth Century America frequently suffered "Panics" as stock markets temporarily declined, and industrial production experienced downturns followed soon after by notable upswings. On the whole, however, growth was steady, in fact, frenetic. The American economy expanded enormously in the century and a half after independence. By the time of the First World War, the United States led the world in virtually all fields of productions. The citizens of this young nation enjoyed a standard of living unlike any that had ever been imagined. In the 1920s, America was the envy of the world. Millions poured into its great metropolises to snap up the seemingly endless supply of good-paying jobs. New inventions made life easier than before. Hunger and want had become things of the past. For the many ordinary people who decided "to play the market," the New York Stock Exchange offered the hope of joining the country's expanding class of millionaires. Great fortunes were made. The rich grew richer, and well even the poor were more secure than in previous times. For several heady years, it appeared as if the Stock Market could go nowhere but up. In vestment and profit grew exponentially. Yet in October 1929, it all came crashing down. Shares on the New York Stock Exchange plummeted in value. Margins were called in. Companies folded. Banks closed their doors. The honeymoon was over. The period known to history as the Great Depression had begun. The hopeful madness of the Jazz Age died out in the piteous strains of "Brother Can You Spare a Dime?"

For the past seventy-five years, historians and economists have argued over what brought on this madness. Indeed, the science of macroeconomics was created in large part because of this single event. What was particularly unusual about the Great Depression, as opposed to other "panics" or economic calamities was its worldwide scope. Virtually every country in the world was affected by that fateful stock market crash, and in exceedingly similar ways. Among the theories that attempt to explain this phenomenon are various hypotheses relating to the classic arguments of supply and demand: aggregate demand as related to the Gold Standard and world money supplies, and aggregate supply as related the failure of world economies to adjust to nominal monetary shocks.

Prior to the 1930s, most of the world's nations operated according to the gold standard; a small number according to the silver standard. In response to the catastrophic failures induced by the events of late 1929, most countries eventually removed themselves from these standards. The Gold Standard had been the prevailing system among all the great economic powers from the late Nineteenth Century through to this period. Suspended briefly for the duration of the First World War, it had only recently been "reassembled" as the result of protracted and delicate diplomatic negotiations; talks that had been completed only a few years prior to the collapse.

Yet research has shown that, the quicker a nation abandoned the Gold Standard, the quicker its recovery from the debacle.

Those nations that held out the longest - for example France - endured the depths of the Depression for a longer period of time.

The gold standard had been essential to the conduct of international exchange until the 1930s:

Countries on the gold standard defined a price of gold at which domestic currency was convertible. In turn these commitments set the mint par parity between a pair of currencies. Owing to the cost of arbitraging gold between countries, the gold import and export points implicitly defined the edges of an exchange rate fluctuation band or target zone. If financial markets thought that national commitments to convertibility at unchanged prices were credible, the expectation for mint par parity would be for no change and the exchange rate would not be expected to move outside of the established gold points. However, if for some reason a country's commitment to a fixed gold price was questioned, there would be some finite probability of a change in mint par parity (or abandonment of the gold standard altogether) and the exchange rate would deviate outside of the gold points.

The United Kingdom withdrew from the gold standard in 1931 leaving the United States and France as the two largest economies still on that standard. It had long been believed that this decision by the British Government put undue pressure on the United States and its Federal reserve. However, the fact was that France and the other major European states remaining on that standard have been to have been more than capable of absorbing excess American gold throughout this period. Until the United States too dropped the gold standard in 1933, France in fact tallied net imports of gold in all but two of the months during this time period. Other nations, such as the Netherlands and Belgium, showed net gold imports in every month of this period.

Much of this one way movement of gold bullion was the result of pressure placed upon the United States to devalue its currency in relation to the franc.

Nevertheless, as revealed by the ability of European nations to absorb American gold, it was not the continued adherence to the gold standard by the United States, France, and other countries, that contributed to the continued worsening of the Great Depression in the early 1930s.

As to the other argument regarding the effect of monetary shocks on the national economies, there is great disagreement as to whether this, by itself, was the primary cause. As stated above, many scholars believe that a combination of both monetary shocks and the attempt to buoy up the gold standard were the essential factors that led to the Great Depression. There is, nonetheless, considerable disagreement, especially as regards whether the student of this period is an economist, or a historian - both seeing the cataclysm somewhat differently:

recent survey of economic historians found that when presented with the statement: 'Monetary forces were the primary cause of the Great Depression', 14 per cent of the responding economists and 17 per cent of the historians agreed, while a further 33 per cent of economists and 17 per cent of the historians agreed, with a proviso. A bare majority of the economists and two-thirds of the historians disagreed. When asked whether the Federal Reserve 'had ample powers to cut short the process of monetary deflation and banking collapse', and whether this 'would have eased the severity of the contraction and very likely would have brought it to an end at a much earlier date', 32 per cent of the economists and 31 per cent of the historians agreed, and another 43 per cent of the economists and 37 per cent of the historians agreed, with a proviso.

These differing opinions point toward still another argument as to the Great depression's causes - that of institutional failure. Most commonly blamed, as shown in the preceding citation, is the Federal Reserve. Once more, it is the contention of many that the United States Federal Reserve's adherence to the gold standard that both led to, and exacerbated existing problems. But clearly, the Federal Reserve was actually functioning quite well in regard to the matter of the gold standard and foreign currency exchange. Also worthy of attention is the question regarding the many assumptions that underlay Federal Reserve policy during this period, namely that body's "non-interference" in much of the economy.

Such a discussion leads inevitably to deeper consideration of prevailing attitudes prior to October of 1929. At this date, the dominant economic philosophy, especially in the United States of America, was that known as laissez-faire. The typical economist, businessman, and politician of that period firmly believed that capitalism was, in effect, a wholly natural system, and as such was subjected to its own laws and patterns, schemes that should not be directly manipulated by the government.

At the onset of the Depression the dominant view among mainstream economists in the U.S. was that the initial downturn of investment and output was a more-or-less normal cyclical phenomenon and that recovery would inevitably follow. Economists disagreed about the proper monetary, wage and price policies for facilitating recovery; but the idea that this recovery might fail to lower unemployment below catastrophically-high levels did not initially enter the heads of mainstream economists. The Depression and associated policy issues were initially viewed in short-run cyclical context rather than as connoting any long-run barrier to a full recovery of investment

The belief in the "naturalness" of the Great depression is surely to blame for the slowness of the response to what was going on. Until it could be discovered - and accepted - that these conditions were anything but normal, it was largely impossible to change accepted policy. As well, the unregulated past had produced the profits of the more recent past, or so it seemed. Never before, though, had there been such system-wide failure as was seen in the early 1930s. The downward spiral of deflation, the collapse of countless banks and other financial institutions, and the unprecedented levels of unemployment all demanded that something be done.

The programs that constituted President Franklin Delano Roosevelt's New Deal were not entirely unknown in the pre-Depression world. Various European countries already possessed social welfare schemes to some extent, but in the United States this was largely new thinking. The changes wrought by the New Deal reflected as much the uniqueness of conditions during the Great Depression as they did the undercurrent of new attitudes and ideas that had gradually been taking hold among America's intellectuals.

FDR's planners acted in the context of changing values, an evolving set of institutions, shifting political and economic circumstances, and the ebb and flow of planning opportunities to create a distinctly national, American form of planning.... They were part of a wide-ranging national debate over how to create a new society based on modern institutions that grew out of developments in the business community, the urban environment, the rise of professionalism and its attendant associations in the social sciences, the recognition of the need for a new kind of twentieth-century liberalism, and the building of new interconnections among business, government, social science research, and philanthropic management.... The proper use of economic policy to respond to changes in the business cycle, and the utility of social scientific expertise in dealing with major questions of public policy.

Just as laissez faire had once been seen as the "natural" state of economic development, so now government planning came to be seen as the ultimate in the application of science and intellect to the economic sphere.

Franklin Delano Roosevelt's New deal brought about sweeping changes in the way Americans did business and in how business and the individual related to each other. Under these programs, the federal Government would contribute massively to the economy as both an employer and a guarantor of Americans' standards of living. In addition, the Government played a pivotal role in the overall institutional structure of American business and finance, and by extension - given the size of the American economy - in that of the entire world. Charles E. Merriam, led an academic crusade to develop the social sciences in the United States. Appointed first by Herbert Hoover, Merriam attempted to revolutionize liberalism by giving to its principles a scientific foundation; one that would suit the needs and aspirations of the Twentieth Century. Merriam Brought to national planning the values of the upper class, the corporate experience of a railroad manager, the city and regional planner's concern for rationality, expertise, and efficiency, as well as real talent for voluntary associational work that crossed private- and public-sector lines.... Merriam emerged as its [the New Deal's] organizer and theorist.

Armed with these new ideas, there would grow up a government that considered the personal well-being of its citizens to be its legitimate preserve.

In simple terms, the New Deal represented an enormous infusion of government money and talent into the private sector - or into those areas that had once been considered to lie within the sphere of private responsibility. To help the millions of unemployed, the Federal Government sponsored great public works projects such as the Tennessee Valley Authority and Hoover Damn, both of which not only employing vast numbers of people, but were also intended to furnish many subsidiary benefits. The Works Progress Administration, or WPA, was in effect, a gigantic government employment consortium. It provided jobs to millions of out of work Americans, but at a tremendous financial cost to the nation:

The chief weakness of the 1935 reform program was that the New Deal failed to secure adequate funding for federal public employment (the WPA). Given the size of the relief caseload in 1935, a large -- and politically unpopular -- public welfare program was inevitable in the absence of a full employment policy. Responding to this reality, federal officials and state-level reformers aggressively promoted the modernization of state welfare programs, essentially transforming the emergency relief organizations into permanent public welfare departments. This process institutionalized state-administered relief.

The result was an almost overnight abandonment of the laissez-faire tradition. Far from staying out of Americans' personal lives, the Federal Government would now become possibly the biggest single actor in those lives. Even where it was not the Federal Government per se that provided the "interference," it was frequently the author of the policies that were being funded and implemented at the state and local levels. Many of the same arguments that were raised against the New Deal at the time of its inception are still being raised against its modern-day descendent - the American welfare state. According to many Conservatives: