Causes and Effects of the Great Depression Explained

The Great Depression refers to the severe economic decline that began in the United States towards the end of 1929 and spread to most industrial countries of the world, lasting until the early 1940s. The period saw sharp declines in the production and sale of goods and a sudden, severe rise in unemployment. Numerous businesses and banks closed down or went bankrupt, people lost their jobs, homes, and savings, and large sections of the population in hitherto prosperous countries were forced to depend on charity to survive. Economists have discussed and dissected the causes of the Depression ever since, and its long-term effects have not been fully overcome even today. This paper discusses some of the important causes and effects of the Great Depression.

The popular misconception about the Great Depression is that the sudden stock market crash of October 1929 caused it. Although the stock market collapse certainly contributed to the subsequent economic downturn, the crash itself was more a symptom than a cause of the economic disease. Some of the major causes are discussed below.

The end of World War I saw the American nation withdraw toward an inward-looking policy of heightened individualism and the single-minded pursuit of wealth. New technological innovations in modern industry enabled a quantum increase in industrial productivity. Unrestrained consumerism was promoted through the newly acquired art of advertising. People were persuaded to buy new, attractive products such as the automobile, the radio, and household appliances. The problem was that while the public could be easily seduced into abandoning their habits of saving and frugality, the majority of Americans did not have the required buying capacity due to great inequalities in income. For example, during the "Roaring Twenties" (between 1923 and 1929), manufacturing output per person-hour increased by 32%, while workers' wages grew by only 8% (McElvaine 38). At the same time, the government initiated massive tax cuts to benefit the wealthy. As a result, the top 0.1% of the American population in 1929 had a total income equal to that of the bottom 42% (Brookings Institute Study, qtd. in Gusmorino). This meant that the vast majority of Americans did not have sufficient income to consume surplus production and keep the wheels of industry turning.

Not to be deterred, innovative businessmen got around this problem by providing easy credit through "buy now, pay later" schemes. By the end of the 1920s, 60% of cars and 80% of radios were bought on credit, and the total amount of outstanding installment credit more than doubled — from $1.38 billion to around $3 billion — between 1925 and 1929 (McElvaine 17). This was clearly an unsustainable economic situation. It is also worth noting that the Revenue Act of 1926 cut the tax rate on incomes of $1 million or more by more than two-thirds, and that the top 0.1% of Americans in 1929 controlled 34% of all savings, while 80% of Americans had no savings at all (Gusmorino).

The agricultural sector in the United States was encouraged to increase production during World War I due to demand for food and farm products in Europe. The U.S. government subsidized farmers and paid $2 a bushel for wheat during the war, but by 1920, when government subsidies were withdrawn, wheat prices had fallen to 67 cents a bushel (Gusmorino). Since agriculture represented a quarter of the U.S. economy, a downturn in the sector was bound to have an adverse effect on the overall economy — and it eventually did. To make matters worse, beginning in 1930, a severe drought hit the Great Plains. Parts of Kansas, Oklahoma, Texas, New Mexico, and Colorado became known as the Dust Bowl as the topsoil turned to dust due to prolonged dry weather.

Most of Europe had been physically and economically devastated during World War I. After the war, the United States assumed the role of the world's chief creditor just as European countries struggled to pay war debts and reparations. American banks that lent heavily to European borrowers ran up huge defaults as countries such as Germany were unable to service their debts due to their devastated economies. The negative fallout on the banking structure began to be felt by the late 1920s (Delong). The role of the Federal Reserve during this period was also less than exemplary, as it took steps that further squeezed the money supply and prolonged the Depression.

To make matters worse, the United States maintained high tariffs on goods imported from other countries, even as it was making foreign loans and trying to export its own products. These tariffs reached an all-time high in the 1920s and early 1930s. Through special Tariff Acts in 1922 and 1930, the U.S. increased its tariffs by 100% or more (Gusmorino). The trade barriers were intended to protect American business, but the policy resulted in falling U.S. exports — $1.5 billion in foreign sales were lost between 1929 and 1933 alone. When European nations could not sell their goods in the United States, they could not earn enough to buy American products or repay American loans. In reaction, America's trading partners imposed similar trade barriers, further worsening the international trade situation and contributing in no small measure to the onset of the Depression.

Most Americans had little money to spare while buying consumer goods during the 1920s — mostly on credit — but the wealthiest Americans had plenty to invest, and they fueled the rapid and ultimately unsustainable growth in the stock market between 1927 and 1929 by buying stocks. Soon the inflated prices of stocks far exceeded the actual worth of the shares and bore no relationship to the profits of the companies or the dividends paid by them. As an example, the RCA Corporation's share price rose from $85 to $420 during 1928, even though it had not yet paid a single dividend. No one cared about dividends as long as stock prices continued to rise and shares could be sold at a profit. The "bull-run madness" even drew less wealthy Americans into the stock market. Shares could be bought "on margin" by paying only a fraction of the share price, on the expectation that prices would continue to rise. For a time, the Dow Jones Industrial Average doubled — from 191 to 381 — in less than two years, from early 1928 to September 1929 (Temin 62–63).

The stock market bubble lasted until October 1929, when on a single day of mass panic — October 29, dubbed "Black Tuesday" — stocks lost between $10 billion and $15 billion in value. Between October 29 and November 13, over $30 billion disappeared from the American economy, a sum greater than what the U.S. government had spent to fight the First World War (Schultz, para. on "The Crash"). The Great Depression was now well and truly underway.