The Great Depression

 A devastating global economic crisis that started with a sharp decline in American stock values. 

Author: Christopher Haynes
Christopher Haynes
Christopher Haynes
Asset Management | Investment Banking

Chris currently works as an investment associate with Ascension Ventures, a strategic healthcare venture fund that invests on behalf of thirteen of the nation's leading health systems with $88 billion in combined operating revenue. Previously, Chris served as an investment analyst with New Holland Capital, a hedge fund-of-funds asset management firm with $20 billion under management, and as an investment banking analyst in SunTrust Robinson Humphrey's Financial Sponsor Group.

Chris graduated Magna Cum Laude from the University of Florida with a Bachelor of Arts in Economics and earned a Master of Finance (MSF) from the Olin School of Business at Washington University in St. Louis.

Reviewed By: Manu Lakshmanan
Manu Lakshmanan
Manu Lakshmanan
Management Consulting | Strategy & Operations

Prior to accepting a position as the Director of Operations Strategy at DJO Global, Manu was a management consultant with McKinsey & Company in Houston. He served clients, including presenting directly to C-level executives, in digital, strategy, M&A, and operations projects.

Manu holds a PHD in Biomedical Engineering from Duke University and a BA in Physics from Cornell University.

Last Updated:November 27, 2023

What Was the Great Depression?

The Great Depression, which lasted from 1929 to 1939, was a devastating global economic crisis that started with a sharp decline in American stock values. 

The stock market crash on October 29, 1929, made the crisis well-recognized, and the economic shock spread worldwide, affecting countries to varying degrees.

This is an example of a severe global economic depression since it was the most prolonged, profound, and pervasive depression of the 20th century.

The world's GDP shrunk by almost 30% between 1929 and 1933. During the Great Recession between 2008 and 2009, the global GDP fell by less than 5%. The detrimental impacts of the depression continued in many nations until the beginning of the Second World War

Falling personal income, prices, tax revenues, profits, and prices had disastrous impacts on both wealthy and developing nations. International commerce decreased by more than 50%, while unemployment in the United States increased to 23%.

What Were the Causes of The Great Depression?

A single event did not trigger the Great Depression. Instead, the economy's downturn was caused by many factors.

Although many factors contributed to the downturn, its effects were felt throughout the nation. By 1933, price levels and productivity had dropped to a third of 1929 levels, the banking system had failed, and about 25% of the working force was jobless.

Contrary to common assumption, the crisis didn't start because of the 1929 stock market fall alone. Instead, the Great Depression resulted from several additional causes, including poorly timed tariffs and poor Federal Reserve policy at the time.

The reasons for this in the United States in the early twentieth century have been widely explored by economists. But, there is disagreement among different economists regarding what caused the Great Depression. 

However, most experts believe that the following events were vital contributors to the decline-

  • Roaring Twenties 
  • Wall Street Crash of 1929
  • Banking panics and reduced money supply
  • Gold standards
  • Smoot-Hawley Tariff Act

Roaring Twenties

It was a time of excessive economic expansion. The construction boom, post-war reconstruction, and the explosive rise of consumer products, like cars and electricity, all contributed to the Roaring Twenties' economic expansion and widespread wealth. 

While the unemployment rate decreased from 6.7% to 3.2% between 1922 and 1929, the GDP increased at a mean annual rate of 4.7%. As a result, the total wealth in the US more than doubled, but the wealthiest Americans benefited the most from this expansion.

The market saw a significant increase in investments made by retail investors. In addition, financial institutions started to speculate a lot on the stock market. An era of irrational stock market speculation had been made possible by lax restrictions. 

And, to make matters worse, many investors acquired shares on margin, often needing just 10% of the price of a company to do so. As a result, share prices were artificially inflated by excessive speculation, going beyond what the fundamentals of shares could support, causing the stock market to crash in 1929.

Wall Street Crash Of 1929

The unprecedented surge in share prices during the years leading to the crash refers to this period as the "roaring twenties." For example, the Dow Jones Industrial Average climbed from 63 in August 1921 to 381 in September 1929, over six times its initial value.

The Federal Reserve Board issued a public warning about the risks of speculating and instructed the reserve banks to turn down credit requests from member banks that lend money to stock speculators.

The Feds reportedly raised the discount rate to 6%, yet the speculative bubble persisted.

An unprecedented boom led to a catastrophic conclusion. On October 28, 1929, known as "Black Monday," the Dow dropped by over 13%. The market plunged by approximately 12% on the next day, also known as Black Tuesday. 

Nearly half of the Dow's value had been erased by mid-November. Dow continued to fall until the summer of 1932, when it closed at 41.22, its lowest value of the twentieth century and 89 percent below its high.

The share price of General Electric decreased from 396 on September 3 to 210 on October 29. Shares of United States Steel declined from 261 to 166, while the common stock of Radio Corporation of America (RCA) plummeted from 505 to 26.

Banking Panics

When several depositors want to receive their bank deposits in cash simultaneously because they are losing faith in the banks' ability to remain solvent, this is known as a banking panic.

Depositors began worrying after the 1929 stock market crash and preferred holding actual cash to making bank deposits. As a result, the first case of bank failure happened in Tennessee.

The public's anxiety and panic grew as rumors spread that banks were purportedly refusing to repay customers' money.

Ironically, a banking panic often has the opposite effect, creating the precise disaster that anxious clients try to avoid. Moreover, a significant panic can bankrupt even financially sound institutions.

Seven hundred forty-four banks closed following the crash in the first ten months of 1930, which is ten times as many. Throughout the 1930s, 9,000 banks ultimately failed. The year 1933 alone is thought to have seen 4,000 banks collapse. 

Depositors have seen $140 billion evaporate through bank collapses by 1933. By 1933, one-fifth of the banks in 1930 had gone bankrupt.

The Gold Standard 

It is a monetary system in which the value of a currency is specified in terms of gold. The Federal Reserve's ability to issue money was meant to be limited by the amount of gold in the United States.

The amount of money that commercial banks could issue. By extension, the amount of money that people, businesses, and industries could borrow from the bank was under the control of the Federal Reserve.

Because the depression began in the United States, gold flowed from other nations, mainly Europe, to the United States. 

To address the trade imbalance, foreign central banks in Europe raised their interest rates, which had the unintended consequence of decreasing output, driving up prices, and boosting unemployment in those nations. 

Thus the gold standard contributed to the depression spreading from the United States to other nations. However, more gold was locked away in the United States and not used to expand the money supply. 

The Federal Reverse did not follow the rules in 1930. It did little as the money supply shrank and banks failed. By 1933, there was a third less money in circulation in the US.

Smoot-Hawley Tariff Act

On June 17, 1930, the Smoot-Hawley Tariff Act was adopted in the US. Originally intended to defend the American economy as the depression took hold, it largely failed. 

According to economists and economic historians, the enactment of the Smoot-Hawley Tariff intensified the Great Depression.

This measure increased US duties on more than 20,000 foreign items. In 1921–1925, import charges were typically 25%; however, under the new tariff, they were increased to 50%. 

The law inevitably prompted retaliatory actions by several other nations, which together had the combined impact of lowering output in many nations and decreasing international trade.

Foreign trade restrictions were common in nations that kept their currencies rigid and adhered to the gold standard. To strengthen their balance of payments and reduce gold losses, these nations "resorted to protectionist practices.

The Act and the tariffs imposed in response by America's trade partners significantly contributed to the 67% decline in American exports and imports during the depression. 

American exports decreased from around $5.2 billion in 1929 to $1.7 billion in 1933 throughout the next four years. 

Recovery and sources of recovery from the great depression

The lack of a coordinated macroeconomic policy response in the United States and many other nations is widely acknowledged as a significant contributor to the severity and duration of the crisis.

In a letter to Roosevelt, British economist John Maynard Keynes recommended increasing government spending for "a program of public works" to lower unemployment. He advised that expenditure increases should be funded by borrowing rather than taxation.

According to some economists, a significant contributor to the recovery was the expansion of the money supply brought on by substantial foreign gold inflows. In addition, the worsening political situation in Europe and the depreciation of the US dollar contributed to the increase in gold inflows.

Additionally, New Deal initiatives contributed to higher economic production and a drop in unemployment from around 25% to 17% by 1936.

Following were a few of the critical factors that helped the economy recover from the Great Depression:

Devaluation And Monetary Expansion

Monetary growth and currency devaluations were the fundamental forces behind the global recovery. When countries begin to devalue their currencies or abandon the gold standard entirely, their output rises.

For instance, Britain, compelled to abandon the gold standard in September 1931, recovered quickly. Still, the United States recovered somewhat more slowly, which did not entirely discount its currency until 1933. 

Similar to this, Argentina and Brazil in Latin America, which started to devalue in 1929, went through comparatively moderate downturns.

Nevertheless, the devaluation helped increase the money supply and, ultimately, the output worldwide. Early in 1933, the American economy saw a significant increase in its money supply. Between 1933 and 1937, the American money supply rose by about 42%.

A significant influx of gold primarily caused this monetary growth in the US. In addition, monetary expansion encouraged consumption by reducing interest rates and increasing credit availability. 

Fiscal Policy And New Deal

The federal government's involvement was enlarged under the New Deal, focusing on assisting the underprivileged, jobless, young people, the elderly, and rural areas.

The "3 R's"—relief for the poor and jobless, restoration of the economy to pre-depression levels, and banking system reform—were the main focuses of the measures.

With the creation of the CCC in 1933 and the WPA in 1935, the federal government actively hired persons for relief and provided direct assistance or benefits.

The Emergency Banking Act and the 1933 Banking Act were implemented during the First New Deal (1933–1934) to address the urgent banking crisis. 

The short-lived CWA granted communities money to run make-work initiatives from 1933 to 1934, while the Federal Emergency Relief Administration (FERA) contributed $500 million for relief efforts. Finally, the Securities Act of 1933 was adopted to avoid a similar stock market catastrophe. 

The First New Deal also included the contentious initiatives of the National Recovery Administration (NRA), which urged businesses in every sector to create a code of conduct. 

These regulations hindered price competition among enterprises, established minimum salaries in each industry, and occasionally curtailed output.

The Social Security Act, the WPA relief program, the National Labor Relations Act, and additional initiatives to assist tenant farmers and migratory workers were all part of the Second New Deal, which ran from 1935 to 1936.

The total spending on relief increased from 3.9% of GNP in 1929 to 6.4% in 1932 and 9.7% in 1934. As a result, 49% of the federal, state, and municipal budgets in 1935–1940 were devoted to social spending.

Impact Of World War II

Economic Historians, particularly Keynesians, tend to agree that the start of World War II marked the end of the Great Depression.

World War II somewhat aided the revival of the American economy. Even though by 1939, real GDP in the United States had increased significantly from its pre-Depression level.

At the same time, the US economy remained somewhat behind the trend, and the unemployment rate remained high. However, these remaining remnants of the Great Depression were eventually reversed when the United States entered the war in 1941.

Because of the military buildup, the government's budget deficit expanded significantly in 1941 and 1942, and the Federal Reserve responded to the danger of war by considerably boosting the money supply.

The economy swiftly resumed its trend course due to these expansionary fiscal and monetary policies, which also helped to bring the unemployment rate down to its pre-Depression level. 

Consequently, even while the war did not serve as the primary catalyst for the American economy to revive, it did contribute to it.

The Great Depression Vs. the 2008 Financial Crisis

One of the similarities between the great depression and the 2008 financial crisis is that both were global financial crises that started in the United States and then advanced to other countries.

Another similarity is that asset price booms and busts preceded both crises. There was the Wall Street boom and crash in 1929. The 2008 financial crisis was brought on by the housing boom associated with subprime mortgages that exploded in 2006.

However, the Great Depression was a more severe crisis regarding the actual economic downturn measured by real GDP, industrial production, or unemployment.

On the contrary, a nearly 30% real GDP decline was seen in the US between 1929 and 1933; the decline between 2007 and 2009 was just around 5%. In addition, more than 10% of Americans were unemployed in 2009, compared to a peak of 25% in 1933.

The banking panics of the 1930s had taught the Federal Reserve a valuable lesson about the necessity of implementing an expansionary open market policy to satisfy all liquidity demands. 

As the federal funds rate was lowered almost to zero and an aggressive quantitative easing program was implemented, the Fed's 2008 financial crisis-related policy was very expansionary.

Researched and authored by Dhruv Tyagi | LinkedIn 

Reviewed and Edited by Krupa Jatania | LinkedIn

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