The Causes of the Great Depression

By the fall of 1932, most Americans had come to perceive the depression differently than they had at its beginning. Growing numbers began to worry that depression, rather than being a temporary and purgative event, marked a permanent condition of material scarcity and economic stagnation.

With fears mounting that the economy is about to slip into recession, it may be a propitious moment to review the causes of the worst economic crisis ever to befall the United States.

I.

The Great Depression was a worldwide phenomenon into which the United States was drawn as much a victim as a responsible agent. The stock market crash of October 29, 1929 did not cause the depression. Rather, the crash was one of the more dramatic symptoms of structural weaknesses in the national and international economies.

Between February 1928 and September 1929 prices on the New York Stock Exchange steadily rose. For eighteen months, Americans enjoyed a “Bull” market in which most investors made money. The cumulative market value of stocks in 1929 reached an estimated value of $67.5 billion with one billion shares traded. But the price of stock had in many cases long ceased to bear any relation to the earning power of the corporations issuing it. The ratio of corporate earnings to the market price of stocks climbed to 16 to 1; a 10 to 1 ratio was the standard. In the autumn of 1929, the stock market began to fall apart. On October 19, 1929 stock prices dropped sharply, alarming Wall Street financiers, stockbrokers, and investors. Big bankers tried to avert a crisis by conspicuously buying stock in an attempt to restore public confidence in its value. Ten days later, on October 29, “Black Tuesday,” all efforts to save the market failed.

By November 13, the crash had wiped out $30 billion in stock value. Most knowledgeable Americans, including Herbert Hoover who had been elected president in November 1928, viewed the crash of the stock market as a necessary and healthy adjustment provoked by inflated stock values and undisciplined speculation. Only paper empires had toppled, Americans reassured themselves. Substantive wealth remained unaffected and intact. Yet, the crash had brought down the economies of a number of European countries. The American economy shortly followed. The Great Depression had begun. 

Table 1: Average Stock Prices, Per Share, 1920-1929

Year     Total      Industrial      Railroad      Utilities 

1920     $7.98           $6.50                $20.86           $13.36

1921      6.86              5.07                  20.15                14.18

1922      8.41              6.35                  23.71                17.39

1923      8.57             6.54                   23.45              18.11

1924      9.05            6.83                   25.02              19.34

1925      11.15             8.69                  29.21               23.28

1926      12.59          10.04                 32.72               24.11

1927      15.34          12.53                  38.17               27.63

1928      19.95          16.92                 40.40              36.86

1929      26.02         21.35                 46.15                59.33

Table 2: Average Stock Prices, Per Share, 1930-1941

Year     Total      Industrial      Railroad      Utilities

1930     $21.03         $16.42             $39.82          $53.24

1931      13.66            10.51                  23.72            37.18

1932      6.93             5.37                    8.75             20.65

1933      8.96              7.61                   12.75             19.72

1934       9.84            9.00                   14.05           15.79

1935      10.60           10.13                   11.78            15.15

1936      15.47           14.69                  17.71             22.47

1937      15.41           14.97                  16.86            19.07

1938      11.49          11.39                     9.15            14.17

1939      12.06         11.77                     9.82            16.34

1940      11.02         10.69                    9.41            15.05

1941       9.82           9.72                    9.39            10.93

Source: Standard and Poor’s Index of Common Stock and Historical Statistics of the United States, Part 2, p. 1004.

Perhaps the most remarkable aspect of the Great Depression was not that it occurred, but that it was so severe and that it lasted so long. There are five underlying reasons to explain the onset of the crisis as well as its severity and longevity.

The Lack of Economic Diversification

The American economy of the 1920s failed the test of diversification. Although not readily apparent at the time, prosperity rested on a few basic industries, primarily construction and the manufacture of automobiles. When these two industries faltered toward the end of the decade, the rest of the economy fell into stagnation. Moreover, by 1929, the 200 largest corporations in the United States (out of a total of 400,000 corporations) controlled 49 percent of all corporate assets and received 43 percent of all corporate income. The 1,350 largest corporations secured 80 percent of all corporate profits. These corporations did not adjust to changing economic conditions. In a period of slowing economic activity and declining purchasing power, for instance, corporations maintained artificially inflated prices. The generally unsound structure of some large corporations introduced a further element of instability into the American economy. When a large firm encountered financial difficulties, those problems often spread quickly to smaller corporate subsidiaries leading to the collapse of the entire conglomerate, which, in turn aggravated unemployment.

The Lack of Disposable Income

The indebtedness and consequent lack of disposable income among growing numbers of Americans strictly limited their purchasing power and their ability to consume the products that industry made available. Consumer demand could not keep pace with supply. This situation created a dual crisis of over- production and under-consumption. Even in 1929, before the worst years of depression, more than 60 percent of American families earned annual incomes below $2,000, then considered the minimum for economic self-sufficiency. These Americans were too poor to afford to buy houses, cars, and in some instances, adequate supplies of food. The laying off of workers that began after 1929 further depleted the purchasing power of American consumers.

One percent of the population, by contrast, received 19 percent of the national income by 1929, compared to only 12 percent in 1919. The 10 percent who earned the highest amounts garnered 40 percent of the national income. These wealthy individuals provided a limited market for consumer goods. Had income been more equitably distributed among a larger segment of the American population, the number of potential consumers would have been vastly increased.

The Lack of an Adequate Credit Structure

By 1929 Americans in general, and especially American farmers, were trapped in a deepening spiral of debt. Farmers had gone into debt to buy more land and equipment during profitable war years, then had faced steadily declining crop prices throughout the 1920s that made it impossible for them to pay what they owed. American agriculture had suffered from depressed conditions since 1921, following a period of about seven years in which farmers had prospered as the result of the First World War. During the 1920s, many of the small banks that served the rural community and the agricultural economy had failed at an alarming rate as their customers defaulted on loan payments.

The Decline of Overseas Commerce

Although the United States was far less dependent on overseas trade than it is today, exports accounted for a significant proportion of American economic prosperity during the 1920s. But by the late 1920s, European demand for American goods had begun to decline for two reasons. First, the increasing productivity of European industry and agriculture, having at last recovered from the war, made it possible to reduce the volume of American imports.  Second, toward the end of the decade, most European merchants and consumers could no longer afford to buy American goods.

Table 3: Value of U. S. Imports, 1921-1941

Year               Value

 in millions of dollars

1921             $2,509

1922              3,113

1923              3,792

1924              3,610

1925              4,227

1926              4,431

1927              4,185

1928              4,091

1929              4,399

1930              3,061

1931              2,091

1932              1,323

1933              1,450

1934              1,655

1935              2,047

1936              2,423

1937              3,084

1938              1,960

1939              2,318

1940              2,625

1941              3,345

Source: Historical Statistics of the United States, Part 2, p. 884.

The International Debt Structure

The international debt structure following the First World War devastated the European economies. The crushing system of reparations that the Allies had imposed on Germany, in addition to the huge debt that the Allies owed to the United States to pay the costs of war and reconstruction, seriously hampered economic recovery. Almost all the profits that European economies managed to generate were devoured by debt. Throughout the 1920s, the leaders of European nations, especially in Great Britain, repeatedly called on American leaders to cancel the debts owed to the United States. The Americans consistently refused, but did agree to restructure the debt payments as long as the Allies also extended the same courtesy to Germany.

In the early 1920s, the German economy was a shambles. Increasing taxation, a huge national debt, a trade deficit, reparation payments, and runaway inflation combined to wipe out the value of savings, war bonds, and pensions that represented years of toil and thrift. To meet its financial obligations, the German government continued to print more paper money, which only made inflation worse and destroyed the value of the deutschmark, the basic unit of German currency.

Before the outbreak of the First World War, the value of the mark stood at a ratio of 4.2 marks to 1 U. S. dollar. In 1919 the ratio was 8.9 marks to a dollar. By early 1923, the ratio was 18,000 marks to the dollar, signaling the collapse of the German currency. By August 1923, inflation in Germany had reached even more absurd levels when a single U. S. dollar could be exchanged for 4.6 million marks; by November the ratio was 1 dollar to 4 billion marks. It had long been impossible for the German government any longer to meet its financial obligations despite the expressed willingness to do so. Germany defaulted on its debts, including the reparation payments to the Allies.

In August 1923, Gustav Stresemann, who served as Chancellor of Germany between August and November 1923, skillfully placed Germany on the path to economic recovery. He declared his willingness to resume reparation payments and issued a new currency backed by a mortgage on German real estate, the one commodity that had held its value. To protect the viability of the new currency, Stresemann ordered the government not print another issue. Inflation receded. Although his government survived only one hundred days, Stresemann had restored national and international confidence in the German economy.

Recognizing that Germany could not meet its obligations notwithstanding Stresemann’s heroic efforts, the Americans and British pressured the French government to permit a restructuring of reparation payments. In 1924, all the Allies accepted the American Dawes Plan, named for Charles Gates Dawes, the American financier, politician, and diplomat, who presided over the commission that devised it. The Dawes Plan reduced reparations according the German capacity to pay.  Between 1924 and 1929 economic conditions in Germany improved. Foreign investment, particularly from American capitalists and the United States government, stimulated and sustained the recovery. By 1929, iron, steel, coal, and chemical production in Germany exceeded pre-World War I levels. The value of German exports also surpassed that of 1913. Real wages for German workers were higher than they had been before the war, and improved unemployment compensation helped to maintain the standard of living even for those out of work.

Germany at last appeared to have achieved economic stability. But neither the Germans nor the Allies had world enough or time. On the eve of the Great Depression, Germany still owed the Allies $33 billion; the Allies still owed the United States $22 billion. The Allies had relied on prompt German payment to meet their obligations. If Germany did not pay the Allies, then the Allies could not repay the United States. To make payments, Germany borrowed funds from private banks around the world, and especially from Americans. When international credit suddenly contracted in 1929, it became more difficult, if not impossible, to borrow money. Without ready sources of foreign capital, first Germany and then the other nations of Western Europe defaulted on their loans, drawing the United States after them into the Great Depression.

II.

Most Americans, including President Hoover, did not initially interpret the crash and depression as catastrophic events. Economic panics and depressions had occurred throughout the nineteenth and early twentieth century, in 1819, 1837, 1857, 1873, 1893, 1907, and as recently as 1921. Leading economists and businessmen explained these economic downturns as part of the cyclical nature of capitalism. Although they had sought ways to minimize and regulate these troubling economic fluctuations, experts believed that depressions often purified the economy, purging it of weaker, less efficient, and less profitable businesses. Not only would the economic system eventually recover, it would be stronger than before. There was thus no need for alarm and no rush to embrace revolutionary solutions to problems that in time would take care of themselves.

Hoover believed that the depression had not arisen from internal defects in the American economy. In his opinion, the depression had resulted from weaknesses in the world economy, such as the instability of international banking, currency, and credit. Restructuring the debt, he argued, was the key to ending the depression. Hoover reasoned that the United States might, from a combination of generosity and self-interest, attempt to salvage the world economic system. Yet, Hoover does not seem to have understood how deeply enmeshed in the international economy the United States had become by 1929. He concentrated his efforts on reviving the American economy, but refused to do more than propose in 1931 a one-year moratorium on the payment of all war debts and reparations, a measure that he later expanded to include all private debts. Hoover’s proposals were economically sound, but they offered too little and came too late to avert a crisis.

The most important action that the Hoover administration took to end the depression in the United States was establishing the Reconstruction Finance Corporation (RFC) in 1932. An agency of the federal government, the RFC was designed to provide federal loans to troubled banks and business and to make funds available to local and state governments to support public works projects designed to bolster employment. Although endowed with a huge operating budget, the RFC did not deal forcefully enough with the problems of the economy to generate significant recovery. Under the direction of conservative Texas banker Jesse Jones, the RFC lent money only to businesses and banks with sufficient collateral, those likely to weather the economic storm of their own accord. The RFC, in effect, remained solvent by refusing to make loans to the institutions most desperately in need. Even Hoover’s most vigorous and expansive program was crippled by the fiscal conservatism that characterized his administration.

By the fall of 1932, most Americans had come to perceive the depression differently than they had at its beginning. They now saw that the depression affected not only one or two but all sectors of the economy from agriculture to industry, from commerce to banking. Americans had also come to fear that the depression would not go away by itself, as economists, businessmen, and politicians had at first predicted. Growing numbers began to worry that depression, rather than being a temporary and purgative event, marked a permanent condition of material scarcity and economic stagnation.

The response of the government proved inadequate. Hoover called for an expansion of local, voluntary relief efforts of the sort that had proliferated during the 1920s. Hoover’s insistence on local management to alleviate the crisis reflected attitudes common among the American people. Most Americans were not inclined to see the federal government as the cause of their problems or the source of their rescue. There were no loud or sustained outcries from the American people for massive federal intervention into the ailing economy. Even as thousands stood in bread lines or sifted through garbage cans in search of food, they blamed themselves for their plight. Unemployed Americans walked the streets day after day looking for jobs that did not exist. When they at last gave up in despair, many stayed out of sight to hide their shame, convinced that they were somehow to blame for depression and thus deserved the misery they now endured.

Americans had elected Herbert Hoover to manage a functioning, prosperous economy, not to fix what did not appear to be broken. The drama of New Deal legislation, particularly in its early days, distorts the image of the years that preceded it. The advent of the New Deal implies that Congress enacted a multitude of laws in response to a public that demanded extensive federal intervention into the economy after enduring Hoover’s inactivity. Such was simply not the case.

Franklin Delano Roosevelt became president of the United States on March 4, 1933, after winning a landslide victory that was more a repudiation of Hoover than an endorsement of Roosevelt. He tallied 22,821,857 popular votes (57.4 percent) and 472 votes in the Electoral College. By comparison, the incumbent Hoover received 15,761,841 (39.7 percent), but only 59 electoral votes. Confidence in Hoover had gradually ebbed since 1928 but had never completely disappeared, as evidenced by the more than 15 million Americans who voted for him. From the outset of his administration, Roosevelt soothed Americans’ fears about the economy. He exuded confidence and hope that the crisis would soon end and conveyed those sentiments to the American people.

He did little else. On March 5, 1933 Roosevelt declared a four-day national bank holiday, closing all banks in the country. He reassured the American people that when the banks reopened on March 9, they would again be solvent. Roosevelt’s action did nothing to restructure and stabilize the banking system, but went a long way toward restoring public confidence. When the banks reopened, Americans stood in line to put their money in, not to withdraw it. Within a month, $1 billion in gold and currency flowed back into American banks. The immediate banking crisis was at an end.

Throughout 1931 and 1932, Hoover had employed an army of social scientists to gather an astonishing quantity of information on every aspect of the economic crisis. From the accumulation of this data Hoover and his advisors had begun to formulate plans and strategies to solve the most pressing economic problems. Hoover, though, was slow to act and, after he lost the election, was hesitant to do so without Roosevelt’s approval, which Roosevelt withheld. When he took office, Roosevelt inherited a wealth of evidence about the state of the economy that Hoover’s researches had collected. Unlike his predecessor, Roosevelt did not hesitate to put these findings to use in an effort to propel the United States out of the depression.

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The featured image is “Farmer in despair over the depression in 1932,” and is in the public domain, courtesy of Wikimedia Commons.