Lessons from the Great Depression

Lessons from the Great Depression

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The Great Depression is one of the most devastating economic events that the United States and other industrialized nations ever faced. The events began with the collapse of the United States stock market in 1929 followed soon after with the collapse of most commercial banks resulting in a slowing down of the purchasing power of consumers. The American economic policy with her European allies also contributed to the economic meltdown that proved catastrophic to the American economy. However, modern economic study continues to learn from these events although they are almost a century old. This paper investigates the main economic lessons that economists such as Keynes assimilated from The Great Depression. Furthermore, it asks whether modern day economists can learn any lessons from The Great Depression.

Economic Analysis, The Stock Market Crash

One of the earliest causes of The Great Depression of the late 1920S in the United States was the collapse of its Stock Market. The American stock market had been overbought, excessively bullish, and overvalued. It continued to rise when the prevailing economic conditions clearly could not support the gains. What followed was a systematic crash that began on October 24^th 1929 when the market resumed with at more than 10% lower (Eigner & Umlauft, 2015). Traders and financiers curbed these low margins by stepping in with inflated bids to prevent panic among the market participants, but the events of Black Monday and Black Tuesday sealed the fate of the stock market.

In 1930, renown economist James Maynard Keynes stated that when the demand of private sector slumps, there is a need for public sector demand to rise to prevent economic meltdown. Therefore, the stock market may have depended too much on demand from the private sectors and the absence of demand when the same demand dwindled away in panic after the beginning of the crash affected the stock market (Mitchener & Mason, 2013). The Federal Reserve also played a role in this stock market crash as their lowered interest rate encouraged more investors to borrow and invest in commodities. Such demand in the banking sector’s products did not correlate with the borrowers’ financial and prevailing economic conditions. Finally, the demand for commodities in the private sector and commodities outweighed supply resulting in a stock market that was overvalued, and extremely bullish.

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Looking back at the collapse of the American Stock market and its contribution to The Great Depression, one finds that the Federal Reserve was part of a larger laxity in the government’s regulatory measures on commodities markets. Therefore, this depression and the systematic collapse of the stock market taught the US government as well as other economic markets, the importance of increased government regulation to prevent over-valuation, and extremely bullish markets from overwhelming financial systems and crippling economies.

Anna Schwartz and Milton Friedman contributed to the understanding of the causes of the Great Depression when they pointed out the role of the Federal Reserve. They supported the Keynesian view that contraction of the private demand should be substituted through public demand in a unique way when they stated that monetary contraction at the end of 1929 should have triggered Central Bank action (Crafts & Fearon, 2010). In their view, better Federal Reserve monetary policy would have identified the potential for depression when the stock market became overvalued and bullish as well as when the commercial banks started suffering bad loans and closing down.

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The Collapse of the Banking Sector

Before the start of The Great Depression of 1929, most of the investors in the American Stock market consisted of traders who had borrowed loans. Additionally, the banking sector was already suffering from the effects of bad loans due to farmers and other small scale investors suffering losses in droughts and other unfortunate occurrences (Mitchener & Mason, 2013). Therefore, the majority of American commercial banks were already in the red by the time the markets collapsed on Black Tuesday. Combined with a glaring absence of sound government monetary systems as well as Federal Reserve support, the American banking sector suffered huge losses in the collapse.

Agricultural, shipping, and automotive construction industries were major sources of the GDP of the United States, Britain and most developed European countries. Concurrently, the majority of these industries were interlinked with agriculture providing most of the jobs, raw materials, and employees. When droughts and other natural misfortunes hit the industry in the mid-1920s, most of these farmers and other small scale businessmen were unable to provide enough output affecting agriculture’s sister industries (Eigner & Umlauft, 2015). These industries formed the largest portion of borrowers for American commercial banks who now faced bad loans in their hundreds of millions of dollars. Unfortunately, the same banks could not sell off debtors’ assets as the adverse effects of the Depression’s effects on consumers’ purchasing power has already settled in. Combined with the laxity of the Federal Reserve to intervene on time, many commercial banks collapsed catalyzing the Great Depression.

What modern day economists can learn from these unfortunate events is that Central banks must work in close coordination with commercial banks to control the amount of liquidity in the economy. Before the Depression, the market was flooded with the commodities and financial products that encouraged consumers to borrow unrestricted. When they were unable to pay back, the banks collapsed (Crafts & Fearon, 2010). Additionally, the laxity of the Federal Reserve in the 1920s and 1930s taught economists to promote Central Bank regulation of commercial banks using liquidity and micro-economic stimuli.

US Trade Policies with Europe

When The Great Depression set in in the late 1920s, the US government moved in to protect its own industries by revising the trade agreements it had with Europe. One way it acted was to impose high tariffs on European imports using the Smoot-Hawley Tariff of 1930 (Mitchener & Mason, 2013). However, the Europeans responded in kind by imposing a huge tariff on American imports dropping the volume of international trade between America and Europe by 60 percent. This move forced President Roosevelt to negotiate for lower tariffs, but by then the damage had been done.

One lesson that modern economists learn from these mistakes during The Great Depression is the impact of fiscal policy on international trade. Before the Second World War, most countries in the industrialized world had a production boom that lowered prices driving most farmers and businesspeople to bank loans (Crafts & Fearon, 2010). However, when the unregulated commodities catalyzed the collapse of commercial banks, international trade was the only source of income and foreign trade. However, in a bid to protect home industries, the government made another error.

Conclusion

The Great Depression of 1929 was caused by a series of unfortunate human and natural events. The droughts and famine of the mid-1920s encouraged farmers to overproduce in the late 1920s leading to surplus and low prices. Such unfavorable conditions drove them and businessmen to banks to borrow loans. Parts of these loans were invested in the commodities market which the Federal Reserve did not monitor closely enough. Eventually, it became extremely bullish and overvalued and precipitated the collapse of banks. In a bid to protect home industries, the US government used the wrong fiscal policies in international trade further collapsing the economy.

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References

Crafts, N., & Fearon, P. (2010). Lessons from the 1930s Great Depression. Oxford Review of Economic Policy, 26(3), 285-317.

Eigner, P., & Umlauft, T. S. (2015). The Great Depression(s) of 1929-1933 and 2007-2009 Parallels, differences and policy lessons. SSRN Electronic Journal, (2), 5-12.

Mitchener, K. J., & Mason, J. (2013). ‘Blood and treasure’: Exiting the Great Depression and lessons for today. The Great Depression of the 1930s, 395-428.