Causes of the Great Depression in the United States Economy
The Great Depression is the worst economic epidemic in the 20th century and the worst in the United States of America. The global economic downturn that began in 1929 as a cause of the crash of the stock market lasted until 1939 was the longest and severe depression experienced by western industrialized nations. Its origin was the United States of America, leading to deflation in the prices of commodities, dropping of demand in credit, disruption of trade that resulted in unemployment and poverty. The effects of the great depression in the United States and the misguided government policies resulted in the fall of the economic output (Rothbard, 2000). It made the great depression rank the second economic catastrophe after the civil war in the American History.
This article will focus and will explain the extent at which the great depression causes originated in the U.S.A and the effects on the economy. This event is important in the history of America and the world economy for its effects to the capitalist system and market.
Stock market crash
In 1929, the stock market crash precipitated events that led to decline in the output of the United States of America. The U.S tight monetary policy that was meant to limit stock market speculation was the cause of the stock market crash. The 1920s had been a good decade, but not a boom period with constant prices with mild recessions in both 1924 and 1927. The Federal Reserve action of raising the rates of interest in 1928 and 1928 in was to slow the rising stock prices but led to depression of sensitive areas such as construction and automobiles resulting in a reduction in production.
In 1929, the stock prices had dropped; investors had lost confidence and the stock market. There was a considerable doubt about the economy's health, consumers pulling out on spending. The decline in prices caused investors to liquidate their holdings, leading the fall in prices (Wikipedians, 2014). This dramatic decline in pricing caused the event to be referred to as the
Great Crash of 1929. The stock market crash led to a reduction of the American average Demand at a substantial rate. The purchasing power and investments in business dropped sharply after the Great Crash.
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The financial crisis caused uncertainty about the future income for business and investors; consumers and business firms avoided purchase of durable products. There was the loss of wealth and depression of spending power of people and brought poverty to people. The result was a decline in the America output and rapid fall in 1929 and throughout 1930. The Stock market crash resulted from the Great Depression, hence unemployment and a decline in production, hence affecting the Economy of the United States of America (Bordo, Goldin, & White, 1998). The stock market crash, therefore, is an important fact that catalyzed the great depression because of its adverse effects on prices, wealth, production output, investments and purchasing power of the consumers and business.
Money, Banking and Deflation
Money is very important in any economy, because it is responsible for the functioning of the economy. The economy can be severely affected when the value or the quantity of money changes dramatically. Too much money in the economy reduces its value, making prices rise hence inflation (The U.S Department of State Office of the Historian, 2014). Prices also rise due to Deflation where there is shrinking or less of the money stock.
In the USA, bank reserves included cash held by banks and deposits kept at the Federal Reserve banks. Bank reserves had less or no interests and disliked by many banks, however, holding less reserve is a risk to banks because they can run short in events of unexpected deposit withdrawals.
The gold standard
This standard of gold was used by the U.S in the 1930s; this meant that dollars exchanged for gold at a fixed price. The law required the Federal Banks and Commercial banks to hold a portion of the reserve in gold coin and bullion forms. Domestic mining’s and inflow of gold from outside increased the gold reserves enabled banks to increase their rates of lending and resulted in the inflation of the money stock. Reduction of the gold reserves resulted in the contraction of the money stock (Hall & Ferguson, 2011). Huge withdrawals of gold or cash reserves in the bank resulted in the reduction of bank reserves, forcing banks to contract their outstanding loans which further reduced deposits, shrinking the money stocks. Speculations also show the attack on the dollar and the USA and Great Britain led to the abandoning of the gold standard in 1931.
The gold standard caused a lot of imbalance in the economy; trade and asset flows resulted to the international flows of gold. In mid 1920s, there was intense demand for Americas such as bonds and stocks resulting to large gold inflows to the United States. The Banks raised the interest rates in order to counteract the tendency of the trade surplus and international gold outflows. Gold standard backfired and resulted in a decline in output and prices and the economic downturn in the United States of America.
Banking panics and monetary contraction
Banking panics results when depositors lose confidence the banks solvency and demand cash payments for their deposits. Banks that only holds a fraction of these deposits is forced to liquidate their loans in order to raise the required cash to pay the many depositors. The hasty liquidation process can cause a solvent bank to fall at a very short time.