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Causes And Effects Of The Great Depression Economics Essay

I will to be telling the story of the Great Depression and uncover the truth behind the source or sources that were responsible and how a range of decisions made by various bankers, politicians, governments and policy makers altered the so called era of the mid 1920’s, consisting of ‘optimism, enthusiasm and confidence’, which had appeared to be sound. I will be using both a mathematical and theoretical approach to reveal the reality behind the Great Depression.

What was the Great Depression?

The Great Depression began in 1929, October 29th to be precise and lasted in the region of the late 1930’s. It was known as the economic disaster of the 20th century, the day itself was referred to as ‘Black Tuesday’. It was the period in which the American stock market crashed. Customs barriers were introduced to prevent imports of foreign goods in America. http://www.bbc.co.uk/schools/gcsebitesize/history/mwh/britain/depressionrev2.shtml

This assisted the world in familiarising with the depression. Economic activity decreased dramatically which was followed by unparalleled unemployment growth. The Great Depression of the 1930’s had led to devastating proceedings after the initial development of society (industrialisation). It was a political, social and economic tragedy that had occurred in the world which had a ‘swelling like’ effect to civilisation. The depression of this time was said to be the ‘most severe depression ever experienced by the industrialised Western world’.

The history of the war

The 1920’s (The development of products – developing economy)

As mentioned before, 1920’s was a time of ‘optimism, enthusiasm and confidence’. automobile industry overtook steel as the most important sector of the American economy. Approximately 10 percent of the annual income of Americans was taken up purchasing cars and trucks and in buying gas, oil, parts, repairs, and other auto-related items. The automobile industry, led by the "Big Three" companies of General Motors, Ford, and Chrysler, fueled the upswing in the economy in the last half of the 1920s. The increasing importance of the business, however, meant that if car and truck sales slipped the entire American economy would suffer. People soon discovered just how closely the auto industry was linked to the general healthiness of the economy following the stock-market crash in October 1929.

The automobile industry in 1929 set a record by selling more than 5 million vehicles.

http://www.enotes.com/1930-business-economy-american-decades/automobile-industry

The confidence and optimism had people scrambling to invest their savings into a portfolio of shares. Investing all savings into the stock market may be seen as an imprudent strategy because the stock market is a very risky investment, but did not appear that away in the 1920’s. According to http://www.thegreatdepressioncauses.com/causes.html, ‘the Dow Jones was at a high of 381 increasing by 200 points from 181 on the 3rd September 1929. The words of Irving Fisher helped reassure people of their investments, ‘Stock prices have reached what looks like a permanently high plateau’. With ‘only loose stock market regulations’, it seemed investors could hypothesize eccentrically. A scheme called margin allowed those with little capital to purchase stocks, despite having insufficient funding to do so. They were required to invest a small percentage of funding themselves, approximately 10% - 20% and the remaining amount would be provided by the broker. Margin calls were issued when the stock price fell lower than the loan amount, resulting in the investor having to pay the loan back immediately. The development of society, which had assisted the social system in regards to progress, was fuelled by widespread hunger for change and growth in power and organisational structures, best described as capitalism. The 1920’s was a time of prosperity and influenced, what some seemed to label, the impossible, due to the events of the World War. But this period of time introduced (history of piece making) (find evidence of bank accounts) And as theory suggests, the higher the invested amount, the higher the share prices will become. (get evidence in 1925 – first noticeable and increased till 1926) (national income chart for uk economy)

Pic

As more people invested in the stock market, stock prices began to rise. This was first noticeable in 1925. Stock prices then bobbed up and down throughout 1925 and 1926, followed by a strong upward trend in 1927. The strong bull market (when prices are rising in the stock market) enticed even more people to invest. And by 1928, a stock market boom had begun.

“Roaring Twenties” economic and cultural boom was fueled by industrialization and the popularization of new technologies such as radio and the automobile. Air flight was becoming common as well.

The Dow stock average soared throughout the Roaring Twenties and many investors aggressively purchased shares, comforted by the fact that stocks were thought to be extremely safe by most economists due to the country’s powerful economic boom. Investors soon purchased stocks on margin, which is the borrowing of stock for the purpose of gaining financial leverage. For every dollar invested, a margin user would borrow nine dollars worth of stock. The use of leverage meant that if a stock went up 1%, the investor would make 10%. Unfortunately, leverage also works the other way around and amplifies even minor losses. If a stock drops too much, a margin holder could lose all of their investment and possibly owe money to their broker as well.Stock Market Crash of 1929 Chart

From 1921 to 1929, the Dow Jones rocketed from 60 to 400, creating many new millionaires. Very soon, stock trading became America’s favorite pastime as investors jockeyed to make a quick killing. Investors mortgaged their homes and foolishly invested their life savings into hot stocks such as Ford and RCA. To the average investor, stocks were practically a sure thing. Few people actually studied the finances and underlying businesses of the companies that they invested in. Thousands of fraudulent companies were formed to hoodwink unsavvy investors. Most investors never even thought a crash was possible – in their minds, the stock market “always went up.”

Causes and effects of the Great Depression

In the early 1929, people across the United States were spending their money on goods and luxuries, the stock markets and new developing financial products that were on the launch stage of the product life cycle. The return on investments seemed so inevitable that bankers were also investing in the stock market, using customers’ savings without their knowledge. This led to an increase in economic activity, hence an increase in GDP. The Federal Reserve realised the ‘optimism, enthusiasm and the confidence’ that had led to “excessive credit-fuelled consumer demand” (http://rsp.org.au/content/great-depression-and-welfare-capitalism), which was the grounds to support GDP swelling “causing price inflation on goods and services”. This awareness had led to the Federal Reserve raising interest rates in an effort to reduce consumer spending. This would allow the overexerted stock market and economy to drop the soaring pace in which it was operating at to prevent the stock market becoming further magnified. Higher interest rates helped the Federal Reserve achieve what they had hoped for as it was much more appealing to savers instead of borrowers because the amount of capital deposited in banks would multiply according to the interest rate set. This spread conviction among depositors which further sourced banks in terms of greater possession in money supply, furthermore a decline in economic activity due to a reduction in consumer spending. Borrowers on the other hand would have to pay the high percentage rate on the amount of capital borrowed, therefore it was likely to lead to a fall in borrowing and hence a drop in consumer spending. According to http://rsp.org.au/content/great-depression-and-welfare-capitalism, “The rise in US interest rates forced up interest rates around the globe, damaging the credit-worthiness of heavily indebted countries”.

There were premature signs of problems arising. On the 25th March 1929, the stock market had stumbled and was an indication of what the future had in store. As margin calls were issued by many brokers, panic had started to build up across the country. A banker named Charles Mitchell reassured people which temporarily stopped the panic by announcing the continuous lending that his bank will carry out. During the later stages of the year, manufacturing and the construction of houses began to decrease, implementing the future events. But people ignored these warnings and those advising others about economic fall were categorised pessimists. Thursday 24th October 1929, began an outbreak of ‘fear’ based selling as investors soon acknowledged the stock boom as being alarmingly inflated. As a result, on Tuesday 29th October 1929,’ the Dow Jones had fallen to 41 points’ from 381 within the period of over a month. To their disappointment, investors were unsuccessful in liquidating their shares had directed to no return. The rich instantaneously became bankrupt after the stock market had crashed on the 24th, 28th and 29th October. “Anyone who bought stocks in mid-1929 and held on to them saw most of his adult life pass by before getting back to even. ” - Richard M. Salsman

http://www.martinfrost.ws/htmlfiles/aug2007/wallst_crash.html

http://www.thegreatdepressioncauses.com/causes.html

Those with money left in the bank began to withdraw it as soon as the stock market had crashed. “Overnight, they had put thousands of banks in danger”. The instigation of bank closures started to begin as millions of Americans withdrew money which had led to “more than 11000 of the nation’s 25000 banks” in turmoil by the year of 1933. With most of the nation based upon credit, banks had no further money to lend, hence a shortage of credit and very poor balance sheets. The banks that did spare a little capital were reluctant to lend as there would be a greater chance that people would default on repayments, due to the depression, which would further diminish the financial situation and status of banks. Nevertheless, banks needed the capital themselves for a chance to survive through the depression. Without any capital, banks would unquestionably have to close as ‘more than 11000 had to in 1933’. http://www.thegreatdepressioncauses.com/banks.html

After taking office in March 1933, Franklin D. Roosevelt did his best to shore up the flagging banking system. When a third banking panic in less than four years threatened, he announced a three-day bank holiday to stop the run on banks by halting all financial transactions. When the banks were allowed to reopen, nearly 1,000 banks had been saved.

 

On January 1, 1934, the Federal Deposit Insurance Corporation (FDIC) was established, and since that time, not one depositor has lost insured funds.

 

Prior to the fall of 2008, FDIC insured bank accounts up to $100,000. The Bush Administration changed those levels to $250,000.

http://www.thegreatdepressioncauses.com/banks.html

Bank lending was used to facilitate those in need of financial support, if banks were to lend capital investment to people who had business ideas or plans in the period of the Great Depression, it may have assisted the process of averting the impact as an ‘increased production and capacity from the capital investment lent by banks would in turn increase the overall production and thus increasing GDP’. http://wiki.answers.com/Q/How_do_bank_loans_help_the_economy_grow But this method had parameters; it would have been unlikely for people to have business ideas and plans in a time of panic and horror. Even if there were business plans, and banks lent the necessary funding for the business to launch, it was improbable that the business would have made any real difference to the economic activity as their products and/or services would not have been affordable as millions were unemployed.

http://www.thegreatdepressioncauses.com/causes.html

A countless number of investors were forced to live on streets and were often surviving on a shortage of food after losing their investments in the stock market, having no further financial backing. This implied further deepening into the economic crisis as demand for products and services came to a halt due to insufficient money supply following a cease in spending. Many considered the following years of the depression to be classed as the most severe period for business activity and unemployment levels. Millions of Americans faced brutal conditions after being forced into conditions of poverty. The depression affected the majority of nations which had led to the course of scarce economic activity when countries struggled to secure its own production.

http://rsp.org.au/content/great-depression-and-welfare-capitalism

Despite the negatives, there were positive aspects of the Great Depression. Divorce rates dropped rapidly, the reason for this wasn’t that couples started to tolerate one another; instead, the expense of legal fees became overwhelming to compensate for. Those who wanted to be married on the other hand were forced to delay marriage. Due to the inflated cost of living and the lack of income earned by families, birth rates had also dropped. Many families had divided as parents could no longer source for the cost of living, resulting in children going astray and many separations among couples. The 1930’s also helped aid the initial stages of preventing sexism. Men had little choice but to rely on their wives to provide a source of earnings for the family to live off. Women took on the roles of domestic servants, clothing manufacturers and more. Employment helped support the escalating phase of female rights within the world. This was an optimistic factor which the Great Depression had conveyed. On the other hand it brought discrimination as women were seen as taking away jobs from men.(50 facts about great depression)

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