World Economic Crisis of the 1920s

Table of Contents

Executive Summary

Table of Contents

1 Introduction
1.1 Problem definition
1.2 Aim of the Assignment
1.3 Scope of Work

2 Reasons for the economic crisis
2.1 Supply of goods
2.2 Monetary issues
2.3 Consumption
2.4 Stock exchange crash
2.5 The Gold standard

3 The U.S. and the Great Depression
3.1 President Hoover’s initiatives
3.2 President Roosevelt’s New Deal

4 Lessons learned

5 Conclusion

References

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Executive Summary

The Great Depression was one of the worst economic crises in the history of mankind. All former great powers suffered from high debts and unemployment. The United States got hit very hard, because of the connection to debt countries, which were additionally indebted among each other like Germany, Great Britain and France. The reasons for the severe effects on the United States can be found in the several fields of economics.

The presidents Herbert Hoover and Franklin D. Roosevelt dominated the U.S. response to the Great Depression. Both presidents had different point of views on the crises, from where they initiated fiscal, monetary and social programs. It was not easy to convince the people of tough measures in times of increasing distrust into economy. The lack of public support in combination with less successful initiatives is one of the reasons, why Hoover failed in the election.

All identified lessons learned are not a blueprint for further recessions. The political context and the scientific basis have a decisive impact. Governments, businesses and consumers are responsible for a stable economic environment. Profit has to be on a sustainable basis flanked by moderate monetary measures.

1 Introduction

1.1 Problem definition

Both crisis and prosperity are a part of economic cycles throughout history. Especially extreme situations affect the behavior of consumers, because there are most likely political, mental and social side effects.^[1] During the twentieth century not only several wars happened, but also severe global depressions. At least since the last financial crisis in 2007 politicians and private costumers have demanded a forecast for upcoming crisis. Additionally, emergency plans based on economic theories and historical data seem to be suitable solutions for current crisis.^[2] But it is difficult to compare recessions, because of the different contexts they happened in. That means responsible authorities can only execute effective measures based on sufficient data and knowledge of economic dependencies. These measures depend also on the political situation, because most initiatives turn out to be unpopular among the people, who have already lost their trust in market recovery by itself.^[3]

1.2 Aim of the Assignment

The aim of this paper is to outline the reasons for the crisis and the counter-measures to overcome the Great Depression. What lessons can be learned from US countermeasures in the 1930s? By initiating monetary reforms and increasing public investments without a balanced budget the Roosevelt administration restored a competitive country on the world market. Although it is difficult to compare different economic crisis, lessons learned have to be identified and evaluated.

1.3 Scope of Work

The structure of the paper contains the introduction into the main reasons for the Great Depression from an U.S. and global perspective. Second, the U.S. administration and their initiatives are analyzed. Here it is important to outline the different strategies and their application. Third, lessons learned for future crisis are identified and evaluated, if they are applicable. Last, an obligatory conclusion and outlook complete the case study about countermeasures during the Great Depression.

2 Reasons for the economic crisis

After World War 1 the United States took over the position of a global military and economic power. The U.S.-government did not make any request for reparations from Germany or Austria-Hungary. Instead, all former allies of World War 1 had to pay back their war debts.^[4] On the other hand, Great Britain and France took reparations from Germany, which had to lend money in the United States to make investments.^[5] This dangerous circulation of money set the ground for high economic growth leading to low interest rates.^[6] That led to a post-war-prosperity also called the “Roaring Twenties” mainly financed by lent money.

2.1 Supply of goods

The influence of the Federal Reserve on production volume turned out to be very extensive. Throughout the Hoover Administration (1929-1933) the motivation to produce industrial and agricultural goods increased, because of high amounts of governmental investments.^[7] Especially in the farming sector the cartel plans of the government became obvious, in order to maintain a stable price for agricultural products.^[8] As result of the artificial pricing, producers realized, that spending had more and more been reduced as their inventories consisted of unsold goods.^[9] This led to U.S.-measures with global effects.

Due to low demand for domestic products Hoover decided to protect his own market from international competition.^[10] He enacted a so-called Smoot-Hawley tariff, which was nothing else than an act of economic protectionism.^[11] At the same time, foreign lending was decreased by the United States, which created recessions in those debt states in advance to the U.S.-crises.^[12] The intention of the tariff in the first place was to secure farmers’ income by pushing domestic demand. But the side effects included also a cut of exports, which shifted the balance in the terms of trade and made it unnecessary either to invest or to produce.^[13] In the end, demand for farming products in the United States almost stayed on the same level.^[14]

2.2 Monetary issues

The Federal Reserve System (Fed) was founded in 1913. In the 1920s the Fed most likely had an inflationist intention by providing regional banks with money to secure their costumers’ loans.^[15] As already mentioned, many farmers used affordable loans to increase their production of agricultural goods. The situation got worse at that point, when prices for farming products began to decline and the market of agriculture nearly collapsed.^[16]

Farmers now started to panic, because they still needed to repay their loans.^[17] This development led to bank panics, when especially private customers started to doubt the ability of small banks to maintain their solvency.^[18] Most of the regional banks did not have a large volume of cash reserves. Consequently, they had to liquidate loans, in order to pay out people’s deposits or had to close down.^[19] Therefore, the Fed tried to contain the upcoming crises (inflation) by reducing the money supply and raising the interest rate.^[20] But the negative side effect of this decision was a decrease of spending.

2.3 Consumption

During the “Roaring Twenties” money was literally cheap. American citizens and companies as well as foreign countries could receive loans with low interest rates.^[21] In consequence, investments into stock market, housing and other goods based on public and private debt were made. In the late 1920s, consumers’ demand for durables had been saturated, which among others reduced the volume of spending.^[22] That means, a decline of production and investments happened before the stock market crash in 1929 and was therefore not a direct result.^[23] Additionally, prices rose almost twice as high as nominal wages, which kept private consumers more and more from purchasing goods.^[24]

2.4 Stock exchange crash

The economic reality of the 1920s led to a twisted perception of prosperity and private profit. Many people had bought shares since there had been a continuous increase of the Dow Jones index. This happened continuously, although the depression had already begun in late 1920s.^[25] Statistics of the Wall Street development prove an excessive increase, which cannot be found in any other business fields in those days. In 1928, the Fed started to raise interest rates, in order to prevent prices from exploding.^[26] But this initiative affected directly investments in housing, construction and the car industry, although there already had been a high supply of housing.^[27] Fed’s intent was to prevent banks from lending money for stock exchange speculation, which led to a recession in August 1929 before the main crash.^[28] The crash of the stock market on October 24 1929 (“Black Thursday”) stopped an overheated stock price rising.^[29] But instead of causing the Great Depression, the crash worsened perception and motivation to invest as a lot of shareholders lost their money. Additionally, lower stock prices led to unemployment and lower output.

2.5 The Gold standard

In the 1920s and the 1930s nearly every country applied the gold standard for their currency value.^[30] By definition, the value of the money was directly related to the gold reserves stored in banks. That made it easy for international currency change, because the price was fixed and valid for all involved countries.^[31] Theoretically, private owners of deposits had the opportunity to withdraw gold from the banks in exchange to their owned money.^[32] Fed had to prevent the U.S.-Dollar from devaluation by monetary actions. Low domestic demand for durable goods caused an increasing demand among international trading partners for American products. Next to negative U.S.-terms of trade, governments were afraid of gold flows into the United States.^[33] Consequently, many countries as well as the Fed raised their interest rates; in order restore the international balance and to save the Dollar. This behavior proved how much the gold standard forced national economies to deflate along with the United States, if they wanted to keep the value of their currencies.^[34]

3 The U.S. and the Great Depression

As mentioned before, the depression had already begun before the stock market crashed 1929. Fed tried to contain the boom by monetary initiatives. Local banks that managed to reallocate their deposits undermined this try of cutting money supply.^[35] “Black Thursday” was the peak of a price development requesting a political intervention.

3.1 President Hoover’s initiatives

Although Herbert Hoover (1929-1932) was considered a “laissez-faire” economist, he shortly after the stock market crash started to intervene in the US-market.^[36] One of his main goals was to stabilize prices for agricultural goods.^[37] On the one hand, he succeeded with his plan, but on the other hand, this intervention encouraged farmers to increase production and therefore the supply of goods.^[38] In combination with Hoover’s tariffs the demand for domestic goods declined decisively. His public spending on the market neither without a positive output nor balanced terms of trade had to be financed by increased taxation.^[39] The high tax rate especially for wealthy citizens worsened the situation for potential investors.^[40]

In contrast, Hoover wanted leading business representatives to maintain the level of wages, in order to keep a stimulus for private consumption.^[41] That means, the president intended to fight decreasing prices with relatively higher wages. As a result, deflation became very high and the output of the economy dangerously low. The Great Depression was obviously a result of Hoover’s federal intervention policy.^[42]

3.2 President Roosevelt’s New Deal

Shortly after his inauguration in 1933 Franklin D. Roosevelt took steps to fight the depression. He also started to invest and create new agencies like the National Regulatory Authority (NRA), but without raising any taxes.^[43] However, the president made it possible to put taxes on alcohol again, because his administration legalized it after the time of Prohibition.^[44] In first year, Roosevelt abandoned other significant principles like the gold standard, balanced budgets and small government. By focusing on monetary initiatives like the money supply, the Roosevelt administration left a margin for actions and set the ground for recovery based on lower interest rates.^[45] Furthermore, Roosevelt declared a “bank holiday” in March 1933, on which the banks stayed closed and none could withdraw his money during panic bank runs.^[46] By temporarily cutting the Dollar loose from Gold, Roosevelt set a new exchange rate for the U.S. currency, which made it possible to expand money supply.^[47]

Another important output of Roosevelt’s New Deal was his social security initiatives. In 1938 he passed a law that set the first minimum wage in U.S. history.^[48] Even nowadays, this kind of political intervention is discussed among economists and politicians. Despite any possible side effects for unskilled or foreign employees, most American workers realized a federal responsibility for them. The trust in the government returned slowly as the perception of the situation became more positive than before.^[49] Overall, all different parts of his New Deal endured until the end of World War 2. Roosevelt did not push the button and the depression faded. It was a long process, which was also influenced by governmental programs during the war.

[...]

^[1] Cf. Ambrosius (2005), p. 287.

^[2] Cf. Räth (2009), p. 203.

^[3] Cf. Ambrosius (2005), p. 289.

^[4] Cf. Ambrosius (2005), p. 294.

^[5] Ibid.

^[6] Cf. Braun (1998), p. 64.

^[7] Cf. Horwitz (2011), p. 2.

^[8] Ibid., p. 2f.

^[9] Cf. Romer (2003), p. 2.

^[10] Ibid., p. 5.

^[11] Ibid.

^[12] Cf. Ambrosius (2005), p. 294.

^[13] Cf. Reed (2010), p. 6.

^[14] Cf. Eichengreen and Irwin (2009), p. 1.

^[15] Cf. Rothbard (2000), p. 214.

^[16] Cf. Reed (2010), p. 6.

^[17] Romer (2003), p. 4.

^[18] Ibid., p. 3.

^[19] Ibid.

^[20] Cf. Bernanke (2004)

^[21] Cf. Ambrosius (2005), p. 311.

^[22] Cf. Braun (1998), p. 64.

^[23] Cf. Rothbard (2000), p. 91.

^[24] Cf. Reed (2010), p. 7.

^[25] Cf. Rothbard (2000), p. 116.

^[26] Ibid.

^[27] Ibid.

^[28] Cf. Bernanke (2004), p. 4.

^[29] Cf. Romer (2003), p. 3.

^[30] Cf. Bernanke (2004), p. 4.

^[31] Ibid.

^[32] Cf. Romer (2003), p. 4.

^[33] Ibid., p. 5.

^[34] Ibid.

^[35] Cf. Rothbard (2000), p. 160.

^[36] Cf. Reed (2010), p. 7.

^[37] Cf. Horwitz (2011), p. 2.

^[38] Ibid., p.2f.

^[39] Cf. Reed (2010), p. 5.

^[40] Cf. McGrattan (2010), p. 3.

^[41] Cf. Horwitz (2011), p.3.

^[42] Cf. Rothbard (2000), p. 337.

^[43] Cf. Eggertsson (2008), p. 1477.

^[44] Cf. Reed (2010), p. 10.

^[45] Cf. Romer (1992), p. 781.

^[46] Cf. Reed (2010), p. 9.

^[47] Ibid., p. 10.

^[48] Ibid.

^[49] Ibid.