Causes of the Great Depression

Margarita Thomas
HIST 1700, Professor Ken Hansen
April 19, 2016

What caused the Great Depression? That is a question that has been studied by
many scholars even until this day. One thing appears to be clear. It was not a single
cause but more a chain of events.
One of these events happened before the Great Depression as an unintended
consequence of the Great War. World War One (WWI) did not compromise the United
States economy, at least not at the beginning of the war. An unintended economic
consequence of WWI would soon be felt after the hostilities had ceased and played a
role in exacerbating the effects of the soon to come Great Depression. During the war
many countries were receiving food supplies from the United States, which was quite
profitable for American farmers. Farmers invested in equipment and land to help their
businesses.1 When WWI came to an end, these farmers continued to produce the same
amount of products, not realizing that the countries that were once at war were already
taking care of their own needs through domestic agriculture. Since the demand for
agrarian goods decreased heavily, American farmers found themselves with lots of
goods and no market for them. Many farmers were unable to repay loans that they had
taken on to increase their production. This started a crisis in American Agriculture in
1920-1921 and will continue even through the prosperity period of the following years.
Another piece of this puzzle, prior to the stock market crash, was real estate
speculation. With the automobile, and the building of new roads, people that lived in
colder areas, became interested in properties where the climate was mild all year, such

1 Farrell, Jacqueline. The Great Depression. San Diego: Lucent Books, 1996. Page 16

as beach property in Florida.2 Speculators started to buy houses at higher prices each
time hoping to sell them at an even higher price. Until prices got so high that nobody
was able to buy real estate anymore.
Another cause to the failed economy was the so called Business Cycle. During
depressions there is not enough demand for goods and services produced.
Manufacturers have to slow down production, this means that they have to lay off
workers and cut back on raw material expenses to manufacture their products. Workers
can no longer afford to go to the doctor, have their hair cut at a barber, or put money
into the economy through other ways, shrinking the economy in the service sector as
well as the manufacturing sector. This downward trend in the economy is called a
depression and is part of the business cycle. The business cycle has ups and downs
and these fluctuations control it.
There are two types of goods, the ones that last for years (durable), examples of
durable goods are: cars, electric appliances and furniture. Demand for these kinds of
goods rises if there is a sense of prosperity and decreases if not. Another way a desire
for durable goods may decrease is if the market becomes saturated with a product and
there is no more desire to buy said product because everyone already has it.
The other type of consumer goods are capital goods which are used to
manufacture other goods, like buildings, equipment and machines. Entrepreneurs invest
in these goods if they think that their products are in demand and they are going to reap
McElvaine, Roberts S. Causes of the Great Depression. Encyclopedia of the Great
Depression, Ed Robert S. McElvaine. Vol 1 New York, Macmillan Reference USA, 2004,
Pages 151-156
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benefits from it. If manufacturers dont think there is a demand for their product, they
dont invest in capital goods.
According to this business cycle, durable goods get old and need to be replaced.
And the cycle starts over. Entrepreneurs invest in more machinery, raw materials, and
need to hire more employees to meet the new demands. The prosperity created by new
jobs increases the use of services again by hired workers and creating a new peak on
the cycle.3
Before the Great Depression, in the late1920s, the economy was at the high of
the business cycle. The manufacture industry flourished building commodity items like
cars, and electric appliances. Many had the means to buy homes as well. Cities had to
build new roads and other infrastructure to accommodate the rapidly growing
populations. This situation created jobs and prosperity.
To help these goods get to the public, aggressive advertisement was developed.
People had to believe they needed all these new fangled items, a way had to be created
to keep the customer unsatisfied and instill a desire to get newly manufactured luxury
items. Values of the past like being frugal or saving in order to buy were looked down
upon.
Late 1920s brought a decrease in demand for all those luxury items. The
economy started to slow down and markets got oversaturated with items that people
already had. Industries started to cut down on production and many lost their jobs, and
consequently there was no money to spend. In October 1929, the stock market
3 "What Caused the Great Depression?" "" by Caldwell, Jean; O'Driscoll, Timothy G. Accessed April 19,
2016. https://www.questia.com/library/journal/1G1-162455060/what-caused-the-great-depression

crashed, but the crash was not the cause of the crisis. America was in a recession at
the low of the business cycle.
Another cause of the Great Depression was the creation of new loan programs
that allowed the middle-class American to be able to buy products on credit by making
payments in instalments. People had a sense of prosperity that allowed them to think
they could repay these loans without difficulties so they started borrowing heavily. When
people started losing their jobs they could not make payments anymore.
Individuals and businesses were not only buying new technology items, but stock
as well. People were buying stock using borrowed money, which they thought they
could repay through gains on their investment. Some investors would buy on margin
with means that they made a small down payment with the hope that their stocks will
pay off by themselves when the value of the stocks went up.

In the fall of 1929 stocks went down by surprise, but began recovering. However,
on October 24th, 1929 investors started to sell what they thought it might be overvalued
stock. After this day, known as Black Thursday, the stock market would never
recuperate.
The next Tuesday, which is known to us as Black Tuesday, there was a general
feeling of panic and many people tried to sell their stock at prices much lower than what
they had paid for it, in order to avoid losing everything as stocks continued to spiral
downwards hurting all investors. Those who bought on margin were especially hurt.
Black Tuesday. Gale Encyclopedia of U.S. History: Government and Politics. Detroit:
Gale, 2009, Student Resources in Context
4

Lenders wanted their money for the stock, and if the borrower would not pay cash, the
lenders just sold the stock to get their money. Some paid cash for their stock with the
hope that the stock market would recuperate, but it didnt and many people lost
everything they had.
Economists have different opinions on what might have caused the market crash.
Some are of the opinion that excessive speculation was the cause creating a market
bubble. This means that stocks were overpriced and the overcorrection was out of
control leading the market to crash. Some think that skeptics started the panic and
everyone wanted to sell afraid that they were going to lose their investments.
Only a very small minority in the United States of America owned stock, about
5%, but started a domino effect that affected the whole society. Many banks had to
close because people were unable to pay their loans, business that invested their profits
in stock market lost a lot of money having to cut down on employees and lowering their
income. Workers now, could not repay their loans and were not spending any money
either, which made the economy get even worse.
The political agenda in the United States of America didnt help the situation
either. There was a push for exporting more than importing. But after WWI, America
provided loans to different countries to help rebuild their economies, which meant that
these countries had to sell more to the United States than buying in order to be able to
pay their loans back and this situation was in direct opposition to Americas plan of
exporting more than importing.

Only months before there was a general sense of prosperity and optimism. In the
words of president Hoover:
We in America today are nearer to the final triumph over poverty than ever
before in the history of any land.5

This sudden failure of the economy, after a period of so much prosperity, had a
very negative psychological effect. People had lost their faith on the stock market,
government, banks, and big enterprises. Pessimism ruled society at that time, making
the United States of America fall into the Great Depression.
Another cause to the Great Depression was the money supply. If there is not
enough money, prices must be lowered which causes deflation. If there is too much
money in circulation, prices go up which causes inflation.
The most obvious example of hyperinflation during 1922-1923 was Germany. At
an inflation rate of a trillion percent every year over 2 years, the mark ended up with a
worth of literally nothing. This inflation created by Germany contributed to the Great
Depression in two different ways. It destroyed the German economy and the economies
of other countries around it for a long time, and it also instilled fear in other nations that
became afraid of inflation. This fear of inflation made countries take strong measures
against inflation not realizing that they were creating a path for deflation.
Before WWI, the gold standard was adopted by major countries because it
provided stability, it meant the money was backed up by a set amount of gold. During

5 McElvaine, Robert S. The Depression and New Deal: A History in Documents. New York: Oxford
University Press, 2000 Page 20

WWI, it was not feasible for many countries to remain on the gold standard. They
created inflation to be able to pay for the war. After the war, most of the nations wanted
to go back to the gold standard. To keep their original currency value from before the
war, countries started to use policies to deflate their money and promote export of
goods hoping that low prices for their products will get more gold back into their nations
to help their currencies. Many countries began to enact deflationary policies which had
an effect on the global economy, including the Unites States of Americas economy.
In an effort to protect their economies, many of the government implemented
tariffs. One of them was the Hawley-Smoot Tariff of 1930, implemented in the United
States of America. Governments, trying to decrease imports by using tariffs, actually
made the depression worse deflating even more their currencies.
John Maynard Keynes, British economist and father of the Keynesian theory,
believed that if people were unemployed they will be very conservative in buying goods.
Manufacturers will see that the demand is low and therefore they will decrease
production and as a result more unemployment will be created. Keynes thought that the
governments had to intervene.6 An increase in spending had to be created to
compensate for the low consumption of the unemployed workers. Measures that the
governments can take to help with this situation are lowering taxes and finding ways to
increase spending. During the Great Depression we see that President Hoover did the
opposite. He raised taxes, on an already burdened economy, in an effort to decrease

6 "Keynesian Economics Definition | Investopedia." Investopedia. 2003. Accessed April

19, 2016. http://www.investopedia.com/terms/k/keynesianeconomics.asp

the governments budget deficit. This policy only caused United States to slip deeper
into the depression.
Other economists, prior to the Great Depression, believed that there was another
way to avoid having the Government directly intervene in the economy. With less
demand, less money would be borrowed from banks allowing for interest rates to
decrease. This fall in interest rates would encourage businesses to borrow money and
increase production. To increase production, jobs need to be created. Workers, once
they have money again, will spend it on consumer goods helping the economy to
recuperate in a non-intervention way.
In the case of the United States of America, the Keynesian theory was proven to
be right. It was not until WWII that unemployment began to fall. The Government started
to deficit spend to subsidize the war, creating jobs and this way finally improving the
economy.
WWI had a definite influence on the economy, for involved countries and also the
indirectly involved ones. Business that increased during WWI should have planned on a
recession after the war, specifically the agrarian sector. Avoiding debt and
overproduction would have helped farmers. Speculation hurts the economy in the long
run, makes prices rise until people cannot pay for goods anymore. Knowledge about the
Business Cycle can help enterprises and Governments plan for and prevent hard
depressions by trying to introduce new goods before markets start being saturated with
goods that are of no use to the public anymore. The excessive use of credit can get a
society into trouble, especially the buying of stock on credit. Panic in the stock market
can make an economy fall in a matter of hours and its effects last for years. Being
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optimistic is always good for the economy if coupled with caution. Some inflation will
help the economy in times of need, deflation seems to be much more damaging. The
gold standard worked before WWI, when there was stability. Trying to get back to the
gold standard right away, after WWI, all the countries at the same time created a huge
deflation driving the global economy into a deep recession. Lastly, how ironic it is that
the economy and unemployment started to recuperate with another war, WWII.

Bibliography
Farrell, Jacqueline. The Great Depression. San Diego: Lucent Books, 1996.Page 16
10

McElvaine, Roberts S. Causes of the Great Depression. Encyclopedia of the Great

Depression, Ed Robert S. McElvaine. Vol 1 New York, Macmillan Reference USA, 2004,
Pages 151-156
"What Caused the Great Depression?" "" by Caldwell, Jean; O'Driscoll, Timothy G.
Accessed April 19, 2016. https://www.questia.com/library/journal/1G1-162455060/whatcaused-the-great-depression
Black Tuesday. Gale Encyclopedia of U.S. History: Government and Politics. Detroit:
Gale, 2009, Student Resources in Context
McElvaine, Robert S. The Depression and New Deal: A History in Documents. New
York: Oxford University Press, 2000 Page 20
"Keynesian Economics Definition | Investopedia." Investopedia. 2003. Accessed April
19, 2016. http://www.investopedia.com/terms/k/keynesianeconomics.asp

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