What Was the Great Depression?
From 1929 to 1939, the Great Depression was the most significant economic slump in the history of the industrialized world. The Great Depression began following the October 1929 stock market crash, which plunged Wall Street into a panic and wiped out millions of investors. In the following years, reduced consumer spending and investment led to dramatic industrial production and employment declines as faltering businesses laid off workers. In 1933, when the Great Depression reached its lowest point, there were over 15 million jobless Americans, and almost half of the nation's banks collapsed.
Advertisement
Throughout its brief history, the United States has seen its fair share of economic panics that led to bank runs and failures. Even if the epidemic of COVID-19 and the Great Recession of 2009 is still very vivid in our memories, it makes sense to begin at the beginning.
What Caused the Great Depression?
Economists still study the Great Depression because they disagree on what caused it. Over the years, many theories have been put forward. However, there is still no one explanation that everyone agrees on for why the Depression happened or why the economy eventually got better.
A lot of money was lost in the panic. Even more important, the impact made people doubt the health of the economy, which made people and businesses spend less, especially on expensive things like cars and appliances. But the Great Depression was not caused by the stock market panic alone, no matter how big it was.
Advertisement
Some economists blame the collapse of international trade on protectionist trade policies.
These are some of the elements that historians and economists frequently cited as having contributed to the biggest economic collapse in human history:
Vulnerabilities in the Global Economy
In the 1920s, nations recovered from the disruption and damage caused by civil war as companies and farms resumed production. However, the structure of the economy in the United States and abroad evolved as the importance of ordinary people purchasing durable items such as appliances and automobiles on credit grew.
While this consumption generated significant wealth for company owners, it also exposed them to unexpected fluctuations in consumer confidence. At the same time, nations that produced and exported many goods became aggressive rivals. The conflict destroyed significant collaboration between states essential to operate the international banking system and other banking panics. The failure to work together to control problems diminished the effectiveness of any nation's attempts to combat a recession.
Financial System
The economic boom of the 1920s contributed to the general notion that it was simple to get wealthy quickly by investing in the right opportunity at the right moment. This is one reason so many average Americans were duped by con artists who sold them dubious schemes, ranging from Florida swampland and nonexistent oil reserves to purchasing Spanish postal coupons and redeeming them for U.S. stamps to profit from the lower Spanish currency.
Advertisement
Yet the most dangerous gaming occurred on Wall Street. Investors increasingly purchased stocks on margin, putting down as low as 10 percent of a company's price and borrowing the remainder, using their shares as collateral. The value of corporate stocks rose, and brokers earned enormous commissions.
But, the bubble had to break finally. On Black Monday, October 28, 1929, the average of the Dow Jones fell approximately 13 percent in a single day. This marked the beginning of an era of catastrophic falls that wiped off over half of the Dow's value in a month. By the apex of the financial crisis that began in 1932, the value of the nation's public enterprises had fallen by 89 percent. Several investors were devastated, and businesses struggled to finance their operations.
Advertisement
Blunders by the Fed
The Federal Reserve System, established in 1913, was intended to maintain economic stability by regulating the money supply. Yet, the institution's actions in the 1920s not only bank failed to prevent the Great Depression but may have contributed to its onset.
This approach resulted in falling interest rates, which promoted borrowing and overinvestment. It also resulted in rampant speculation and a stock market bubble. Ordinarily, excessive investments would increase interest rates, serving as a natural barrier to prevent a drop formation. This did not materialize thanks to the young Fed's soft monetary policy.
Advertisement
In 1929, however, the Fed's board became concerned that speculation had gotten out of hand and slammed on the brakes by reducing the money supply and increasing interest rates.
The Federal Reserve's attempt to chill the stock market succeeded almost too successfully. They caused the stock market to decline. Afterward, though, the temperature dropped significantly and rapidly.
The Gold Standard
In 1929, the United States—like many other countries at the time—was on the Gold Standard, with the dollar redeemable in gold and pegged to its value. But after the Wall Street panic, nervous investors began to trade their dollars for gold. During these times, gold was used as a hedge against inflation.
Advertisement
Gold has always been thought of as something special and valuable. They know that owning gold can be a good way to protect against both inflation and deflation, as well as a good way to spread out your portfolio. Gold can also protect your finances when political and economic situations are uncertain.
The Smoot-Hawley Act
Trade protectionists in Congress adopted the Smoot-Hawley Act, drafted at the beginning of 1929 when the economy was thriving. But President Hoover signed the bill into law when the Wall Street Crash crippled the economy in 1930. To protect American companies against foreign nations' lower-priced goods, the measure increased U.S. tariffs by an average of 16 percent. Nevertheless, the strategy backfired when other countries imposed duties on U.S. goods.
Advertisement
If you are a country that imposes tariffs, it may benefit your domestic industry, as domestic energy production may increase for domestic consumption. But if other nations respond, it might be detrimental to everyone.
Stock Market Crash
On October 24, 1929, when jittery investors began dumping overvalued shares en masse, the expected stock market crash finally occurred. This day is known as "Black Thursday" due to the record 12.9 million shares traded.
Five days later, on "Black Tuesday" (October 29), around 16 million shares were exchanged when another panic wave rocked Wall Street. Millions of shares were worthless, and investors who had purchased equities "on margin" (with borrowed funds) were entirely wiped out.
Advertisement
As a result of the decline in consumer confidence following the stock market fall, factories, and other companies slowed output and began laying off employees. For those fortunate enough to maintain employment, incomes and purchasing power declined.
Bank Failures and the Federal Reserve System
Banking Panics
In the fall of 1930, economic recovery looked imminent. The average duration of the preceding three contractions, which occurred in 1920, 1923, and 1926, was fifteen months.1 The economic decline that began in the summer of 1929 lasted fifteen months. A practical and robust rebound was expected. In November 1930, however, a series of commercial bank crises transformed a regular recession into the onset of the Great Depression.
Advertisement
Over 8,000 commercial banks belonged to the Federal Reserve System at the onset of the crisis, but almost 16,000 did not. These nonmember banks functioned in conditions comparable to those that prevailed before the Federal Reserve's establishment in 1914. This climate was conducive to banking crises.
From 1921 through 1936, the total number of bank suspensions is depicted in chart 1. A curve plotted using data. Units are annual bank deposits. A vertical line in 1929 represents the start of the stock market meltdown. A second vertical line at 1933 means the 1933 banking vacation. The number of yearly bank suspensions between 1921 and 1928 was fewer than one thousand, as seen in the graph. 1929 saw the beginning of an increase in the annual number of bank closures, which peaked in 1933 before falling to virtual nil following the banking vacation.
Advertisement
From 1921 through 1936, the total number of bank suspensions is depicted in chart 1. A curve plotted using data. Units are annual bank deposits. A vertical line in 1929 represents the start of the stock market meltdown. A second vertical line at 1933 means the 1933 banking vacation. The number of yearly bank suspensions between 1921 and 1928 was fewer than one thousand, as seen in the graph. 1929 saw the beginning of an increase in the annual number of bank closures, which peaked in 1933 before falling to virtual following the banking vacation. (Data: Federal Reserve Bulletin, September 1937. Sam Marshall, Federal Reserve Bank of Richmond, generated the graph.
Advertisement
One factor was the habit of counting checks as part of banks' cash reserves throughout the collecting process. These "floating" checks were included in the checking accounts of both the bank in which they were placed and the bank on which they were drawn.2 In actuality, though, the cash was located in a single bank. At the time, bankers referred to reserves made up of float as false reserves. The number of fictional accounts increased during the 1920s and reached a high immediately before the 1930 financial crisis. This meant the banking system had fewer cash (or natural) reserves for emergencies. (Richardson 2007).
Advertisement
The Smoot-Hawley Tariff
The Smoot-Hawley Tariff Act of 1930 aimed to safeguard American farmers and other businesses from foreign competition. It is now commonly believed that the Smoot-Hawley Tariff Act exacerbated the severity of the Great Depression in the United States and worldwide.
The law is officially known as the United States Tariff Act of 1930, although it is more popularly known as the Smoot-Hawley Tariff or the Hawley-Smoot Tariff. Sen. Reed Owen Smoot (R-Utah) and Rep. Willis Chatman Hawley sponsored the bill. (R-Ore.).
Recovery
For their part, lawmakers made banks join the Federal Reserve System and approved deposit insurance so that bank failures in the future wouldn't ruin people's life savings.
Advertisement
The bank failures extended excessive credit
The reckless speculation that led to the 1929 stock market crash and subsequent Great Depression could not have occurred without more bank failures, which supported the credit boom of the 1920s. New enterprises, such as those manufacturing autos, radios, and refrigerators, borrowed money to finance their production growth. Even as corporate inventories increased (300 percent between 1928 and 1929 alone) and American salaries stagnated, they continued to borrow and spend. Ignoring the warning indications, the bank failures continued to subsidize them.
The banks also supported the speculation by giving individual investors the funds necessary to purchase stocks on leverage. This farmer from the Midwestern United States might have borrowed up to ninety percent of the funds she needed to make an overnight killing on the automotive stock from her local bank. Bank failures dismissed or minimized mounting indications that Americans were overextended. In the years preceding 1929, farm revenues, in particular, plummeted, while salaries for others remained flat. Their affluence was entirely attributable to their stock market fortune, which did not endure.
Advertisement
The banks disregarded the Federal Reserve
The Federal Reserve, the United States central bank, attempted to reign things in, although too slowly and too late in the game. The Fed itself extended loans, advising them to ease off the accelerator. With their sights fixated on the "easy" gains to be made by backing speculation, banks paid little heed. The more investment earnings their clients produced, the more money they had to spend on new residences and consumer items. Why fret? When the Fed slammed on the brakes in 1929 by raising interest rates, it was too late to prevent the bank panics, the banking system, or its repercussions on banks.
Advertisement
Banks Failed to Keep Sufficient Reserves
Managing their cash reserves is one of the ways that banks contribute to the health of the economy and help prevent calamities such as the Great Depression. Generally, banks retain just a tiny portion of the depositors' funds and lend out the remainder to earn a profit; this is how they generate revenue. In normal circumstances, bank depositors rely on the capacity to borrow from other financial institutions or the Federal Reserve bank and federal deposit insurance corporation to meet any unforeseen deficit in reserves if clients begin demanding their deposits back in large numbers. In addition, many American banks had not joined the Federal Reserve bulletin banking system and could not use their bank reserve banks collapsed.
Advertisement
The banks only recognized what they'd done once the stock market fell, banks failed, and banks panicked. Americans went to banks to withdraw funds so they could hide them under the mattress or use it to offset their significant stock market losses. They had not maintained sufficient reserves to manage the mounting risks linked with out-of-control lending and speculation.
Unfortunately, when banks collapsed and attempted to fix their errors, they worsened the situation. As member banks tried to safeguard themselves, they ceased lending money. Companies could not obtain finance, so they shuttered their doors, putting millions of people out of work. The unemployed could not continue spending, and the downward spiral persisted. When bank after bank failed, funds were lost, but also information: There was no mechanism for surviving institutions to determine whether businesses or individuals posed favorable credit risks.
Advertisement
Could It Happen Again?
Could another Great Depression occur? Possibly, but it would need a repetition of the bipartisan and catastrophically misguided policies of the 1920s and 1930s.
Summary
Hundreds of two banks failed during the Great Depression, and loss of confidence led to "runs" on banks as nervous depositors attempted to withdraw their funds before the banks crashed.
Nine thousand banks failed, taking $7 billion in depositor assets with them. And deposit insurance did not exist in the 1930s; this was a New Deal reform. When a bank failed, the depositors were left with nothing. Due to the banking holiday, millions of Americans lost their life savings.
Advertisement
Because of this, gold has always been considered unique and valuable. They know that gold can be an effective hedge against inflation and deflation and a tool to diversify a portfolio. Gold can also safeguard your finances in unstable political and economic contraction.
