The Great Depression

Tarunya Shankar

Editor’s note:

The Great Depression lasted from 1929 to the late 1930s in the USA, preceded by a conservative regime that advocated laissez fair, allowing the market to be and to fix itself. This principle fell apart as hundreds of thousands of people became unemployed and destitute, businesses began to fail, and the prices of purchasing commodities fell. It occurred primarily due to money hoarding – leading to a fall in consumer as well as investment demand. Laissez faire was followed steadfastly, and the New Deal taxing only depressed the economy while benefiting the privileged. This paper also examines the aspects of the Keynesian theory, as well as the stock market crash of 1929.

Introduction

The period of economic turmoil between 1929 and the late 1930’s is known to the world as The Great Depression, and this depression continued until the start of the second World War  II. The essential reasoning behind the depression was analyzed and explained by John Maynard Keynes, a man known as the Father of Modern Economics. Keynes stated,

“In a normal economy, there is a circular flow of money. My spending becomes part of your earnings, and your spending becomes part of my earnings. For various reasons, however, this circular flow can falter. People start hoarding money when times become tough; but times become tougher when everyone starts hoarding money. This breakdown results in a recession.”[1]

From the start of the 1920’s till World War II broke out, the presidency continually fell into the hands of republican representatives and thus persisted a conservative regime that promoted the notion of laissez faire, that is, to leave the market be and allow it to fix itself, regardless of its ups and downs, until the early 1930’s.[2] Such a principle could no longer be followed towards the late 1920’s as the Great Depression reared its ugly head. This depression saw 10,000,000 people across the United States, Great Britain and Germany, out of work and destitute.[3] A large number of businesses began to fail as they could not make any profit or expand their business. The price of purchasing commodities fell at a much higher rate than the cost of production. In fact, the cost of production barely fell and many businesses struggled to stay open, and the unemployment rate skyrocketed. Keynes stated with regard to this subject matter,

“The time which elapses before production ceases and unemployment reaches its maximum is, for several reasons, much longer in the case of the primary products than in the case of manufacture. In most cases the production units are smaller and less well organized amongst themselves for enforcing a process of orderly contraction; the length of the production period, especially in agriculture, is longer; the cost of a temporary shut-down are greater; men are more often their own employers and so submit more readily to a contraction of the income for which they are willing to work; the social problems of throwing men out of employment are greater in more primitive communities; and the financial problems of a cessation of production of primary output are more serious in countries where such primary output is almost the whole sustenance of the people.”

Many business owners attempted to restore the equilibrium by reducing the output and thereby reducing cost of production or by reducing employees wages, but a reduction in wages did not balance out the economy but rather resulted in a reduction of the purchasing powers of the employees who were consumers also, and it lead to an overall fall in sales proceeds.[4]

An economy survives on the circular flow of money, and one’s expenditure is another’s income and employment is at a natural flow, as one’s failure to earn affects his ability to spend, and thus the balance was to be maintained.[5] The reason for the Depression according to Keynes was so simple that President Roosevelt dismissed it by simply stating it to be, “too easy”.[6] Keynes’ theory was that the depression began because for whatever reason, people began hoarding money, reducing their expenditure to the minimum and stockpiling their savings, and this affected the above mentioned circular flow of money.[7] The researcher will address the questions of the reasons for the hoarding of money by the mass populace, laissez faire, the application of the Keynesian General Theory, the effect of the Wall Street crash of 1929 on the Depression as well as the end of the Depression, the eruption of World War II and it’s positive effect on the economy and finally the emergence of Keynesian economies across the globe.

Reasons for money hoarding

In the 1800’s, an economist named Jean Baptiste Say patented Say’s law, which essentially stated that, “Any amount of output supplied to the market will always generate an equal amount of demand”. Keynes was the first to dispute this law many nearly a century later in his book, The General Theory of Employment, Interest, and Money(1936),[8] by pointing out that the economy no longer ran in the traditional fashion of a barter economy and money was used not merely for transactions in the market but saved up for future use and even held onto for speculative purposes and investments.[9] Keynes in his calculation of the aggregate used only two units, that is, money-value and quantities of employment[10], and he further divided his theory of the flow of money into 4 distinct individual flows, being, consumer spending, business spending or investment, government spending and finally the expenditure of foreigners on exports from US.[11]

Domestic income is divided into consumer spending, that is, expenditure and savings, a portion of which is invested in businesses to help circulate the flow of money and employment that is dependent on the existence of businesses, and if the savings is used entirely on investment of machinery or other equipment, then the output supplied is equivalent to the income spent.[12] However, if only a minimal amount of savings are invested or none at all, there is insufficient income being spent on perpetuating demand. This results in a fall in both consumer demand and investment demand. But the output supplied remains the same and is higher than the demand. This leads to massive losses for both the business and the consumers as businesses find themselves unable to sustain at their current monetary level and are forced to reduce employment.[13]

There could be innumerable reasons for consumers wishing to save money rather than invest or spend. They could be doubtful of their economies strength or the market’s strength, they could be reeling from a possible or existing stock market crash, or they could simply be withholding it for future spending or personal obligations.[14]

To properly analyze a country’s economy, the spending of the government must also be taken into account, as well as their income in the form of taxes, which must be considered as a portion of the consumer’s income that could have been spent on consumer commodities and services or investment.[15] Keynes’ logic was simply that if the consumers no longer had faith in their economy and were no longer willing to pour their minimal income into it or were racked in debt, then it was the duty of the government to expand the money supply by spending money and return to the market its original flow, or by creating money to increase the supply.[16] Rejection of this logic by the American Government, under the power of President Roosevelt, lead to massive inequality of wealth, where the rich became suppliers of the commodities that the poor were too poor to afford and this led to the inability to come out of the depression.[17]

Laissez faire

With regard to the aspect of laissez faire, it is defined in Merriam-Websters dictionary, “a doctrine opposing governmental interference in economic affairs beyond the minimum necessary for the maintenance of peace and property rights”. It was for this reason and the President’s steadfast belief that this principle was to be followed that stopped the government from intervening and expanding the money supply to propagate spending among the general population, especially those in debt. In John Maynard Keynes opinion, the government in power was not one capable of holding up the new economic regime of capitalism.[18] He stated,

“If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.”[19]

This principle had been steadfastly followed in economies throughout the globe and were also entertained in the economy throughout the 1920’s and through Republican President Herbert Hoover’s term in the United Stated economy,[20] though it was not properly applied, in the opinion of Keynes.  In 1932, he stepped down from the political office and was replaced by Democratic President Franklin Delano Roosevelt who used the period of economic turmoil that the American citizens were suffering through to promote a capitalistic ideal.[21] The complete removal of laissez faire, too, was frowned upon by Keynes. President Roosevelt instituted his infamous New Deal at this time, which existed to provide relief to the families of unemployment and poverty as well as provide employment to skilled and unskilled workers.[22] However, the Democratic President, in his role as optimist, failed to take into account the human element, the natural infiltration of greed and corruption in any economy, especially one that had suffered such losses as the American Economy during the Great Depression. The money often never reached the families they were intended to, and priority for employment was given to families who could afford to pay those in positions of power or to those who were related to government workers, a fact attested to by many who struggled through the Depression and were forced to take welfare checks. Jim Powell, a Senior Fellow at the Cato Institute in Washington observed,

“It didn’t bother Roosevelt that New Deal policies contradicted one another. When an adviser gave FDR two different drafts of a speech, one defending high tariffs and the other urging low tariffs, FDR told the adviser: “Weave the two together.” The Agricultural Adjustment Act forced food prices above market levels, in an effort to help farmers, but higher food prices hurt everybody who wasn’t a farmer. The National Recovery Administration forced up prices of manufactured goods, hurting farmers who had to buy farm tools and equipment. Agricultural allotment policies cut cultivated acreage, while the Bureau of Reclamation increased cultivated acreage. Relief spending helped the unemployed, while corporate income taxes, undistributed profits taxes, Social Security taxes, minimum wage laws, and compulsory unionism led to higher unemployment rates. New Deal spending was supposed to stimulate the economy, but New Deal taxing depressed the economy.”[23]

In his analysis, Powell pointed out the flaws of the New Deal system and boldly argued that those given the purpose of enforcing the New Deal and providing relief for those in need ended up twisting the system to force families to pay for welfare and food rationing, payment made with money they did not have or could not afford to spend.[24] The removal of Laissez Faire turned out to be as damaging as its previously existing presence.

Keynesian general theory

John Maynard Keynes was the father of Macroeconomics, and believed that for America to remove itself from the violent slump of the Great Depression, the economy must be analysed and studied as a whole, that is, a study of aggregate demand and supply, aggregate employment and the aggregate economy.[25] Keynes theory of employment revolved around the need to properly examine the actual employment of resources in the economy.[26] This theory is essentially based on two postulates introduced by Keynes. They are :

  1. The wage is equal to the marginal product of labour

That is to say, the wage of an employed person is equal to the value which would be lost if employment were to be reduced by one unit (after deducting any other costs which this reduction of output would avoid); subject, however, to the qualification that the equality may be disturbed, in accordance with certain principles, if competition and markets are imperfect.

  1. The utility of the wage when a given volume of labour is employed is equal to the marginal disutility of that amount of employment.

That is to say, the real wage of an employed person is that which is just sufficient (in the estimation of the employed persons themselves) to induce the volume of labour actually employed to be forthcoming; subject to the qualification that the equality for each individual unit of labour may be disturbed by combination between employable units analogous to the imperfections of competition which qualify the first postulate.”[27]

These two postulates require the wages of employed persons to ensure equality, that is, if the wages are unfair, the poor would be forced to save their income rather than spend lavishly or even occasionally, and they would be forced into destitution. The second postulate is most applicable to frictional unemployment, one of the most beneficial, widespread and natural forms of unemployment, where persons unemployed are only so temporarily and are often prepared for their period of unemployment.[28] The idea of the postulates was that the utility of the marginal product would provide an equilibrium against the disutility of the marginal employment, and thereby reduce unemployment and benefit the economy on four distinct levels, employment being a much needed resource during the Great Depression.[29] The four levels are, first, organization structure being improved to reduce frictional unemployment and then reduction in disutility of labour would decrease voluntary unemployment.[30] There would further be an increase in marginal physical productivity of the commodities industry that was dependant on the wages earned by Arthur Cecil Pigou.[31] Finally, there was to be an increase in the price of non-wage goods, or luxury items, usually mass produced by industries that employed wage owners and the result was a massive shift in expenditure from wage earners to non wage earners.[32] The idea was to shift the brunt of spending to the rich and to remove the poor from pure poverty and debt and instill in them a sense of safety to spend.

Stock market crash of 1929

The early 1900’s were a period of booming economic stability and profit as capitalism emerged and the world recovered gently from the First World War. It was in this period that Laissez Faire was adopted. However, the general public’s dependence on credit bonds and stock market shares continued to rise annually rapidly until such a point that hardly any money-cash was exchanged between hands. The reliance on the stock market would come to be the essential cause for the crash.

On October 24th, 1929, a record making 12,894,650 shares were exchanged at the New York Stock Exchange.[33] Many investors remained optimist, convinced that their careful placement of their money would only result in good things, as the market proceeded to make a comeback as the stocks continued to fluctuate.[34] On October 28th, the Stock Exchange showed a whopping 9,250,000 shares traded.[35] The next day would forever been known throughout the world as Black Tuesday. Black Tuesday was the attack of several years of heavy credit rearing back on its hind legs as 16,410,030 shares were traded on that day.[36] People began to add to the pressure on the market by dumping their securities and in the mad rush to sell, there was no recovery to be seen and on Thursday, the Dow Jones closed at $230 which was a 23% downward movement from its opening, and the Stock Market had officially crashed.[37]

The assumption is that the crashing of Wall Street and the stock market is what first ushered in the Great Depression, which was then urged on by a multitude of other factors.[38] People who had invested in the stock market or borrowed huge sums of money to invest were trapped either in poverty or debt.[39] Banks that offered loans at a fair interest rate could no longer afford to do so and in many cases were unable to stay afloat, like most businesses during this time period, as they were unable to retrieve the money owed for the innumerable loans given.[40] The banks only began to marginally function again after President Roosevelt’s declaration of a “bank holiday” where the banks were to be closed for three full days and when reopened, they would operate warily, with firm restrictions on the amount that any person could withdraw.[41]

End of the depression – World War II

Robert Higgs, a Senior Fellow in Political Economy, in his book often referred to the period after the Second World War as the Great Escape, a pun on the Great Depression, his belief being that the period after the war encouraged the idea of “wartime prosperity”, which pulled the economy out of its slump.[42]  He stated,

“During the war years, the economy operated essentially as a command system, and as a result, the normal measures of macroeconomic performance (e.g., gross domestic product [GDP], the price level, and the rate of unemployment) were either conceptually or statistically incomparable with corresponding measures before and after the period subject to the wartime distortions.”[43]

The government spending skyrocketed as millions and tens of millions were spent on munitions, arms and warheads. This restarted the arms and munitions industries and gradually the flow of money was restored to the economy, and unemployment dropped as 12 million unemployed but skilled persons were drafted into the army and millions of others rushed to secure employment in fields that would exempt them from serving in the military.[44] The bombing of Pearl Harbour catapulted America into the second World War and as spending on defense and military increased, civilian consumption followed.[45] Higgs (2006) believed that the economy pulled itself out of the slump during the war gradually and through many phases, the first being the economy during the transition into war, where the government began spending and the industries slowly began to function again and that was followed by the war-time economy, where spending was high, employment was high, and so was the death toll.[46] The next was what he referred to as “The Great Escape”, the “demobilization and decontrol” of the war command and the armed forces, as the war ended.[47] The period after the war was the true period of prosperity that denoted the end of the Depression.[48]

Conclusion

The Great Depression began with the stock market crash of 1929 and the monetary policies of the Federal Reserve of the United States, and this economic crisis, like a plague, spread across the world, affecting most of Europe, North, Middle and North-East Asia, South Africa, the Soviet Union and even Latin America. The south Asians countries, though not enormously affected or documented during this time period, undoubtedly felt the blow as well. The Depression lasted for over ten years and hundreds of thousands of immigrants that had settled in America for a prosperous life were left destitute, parents with five mouths to feed and no income of any sort. For three years, under the power of President Herbert Hoover, the economy showed no chance of restoring to its original glory, the prosperity and the bubble that had once been cherished during the 1920’s. Those years of prosperity existed through the magic of credit, the refusal to part with physical cash monies, and when the dam burst, the Dow Jones crashed, those who had invested were buried, often literally so, in debt and those that had trusted their money with the banks, found that their years of savings were simple gone. President Roosevelt, taking his place in the Oval Office in 1932, introduced capitalism and optimism to the American citizens in the form of his New Deal, a well-intentioned but impractical solution as argued by both Higgs and Powell. Those with money were untouched by the Depression and the implementation of the New Deal. Those without money seemed to somehow end up with less. Stories of such times speak of the head of a family of five or six, paying three dollars every week to a welfare agent to receive a twelve dollar check. To each citizen, rich or poor, every dollar had value, and that was a value they intended to claim as their own. How could high prices, high unemployment and insurmountable debt not lead to greed and corruption, and why was the President, in his optimism unable to foresee that? The economy was in such a state of hopelessness that the country was forced to rejoice at the prospect of joining the Second World War The lives of millions of soldiers were lost or permanently damaged, many giving the education, their livelihood, their families, but it was all for the greater good; people were spending again, and employment was at a new all-time high. The colour was slowly returning to America’s pale cheeks. Keynes’ belief that any spending, even by the government, would return the flow of money into the economy proved to be correct, and it was realized only a mere ten years late. The arms and munitions industry flourished and it paved the way for all other industries to do the same, and as the government poured funds into defense, the civilians poured money into basic consumption. In 1945, World War II ended and the death and destruction came to a halt, as did the Great Depression. In 1946, the economy prospered and prosperity persisted.

Edited by Neerja Gurnani

[1] J M Keynes, ‘The Great Slump Of 1930’ [1930] TGS 1, 1

[2] ‘Causes Of The Great Depression: A Review of Keynesian Theory’ (http://www.huppi.com ) <http://www.huppi.com/kangaroo/Causes.htm> accessed 29 March 2013

[3] J M Keynes, ‘The Great Slump Of 1930’ [1930] TGS 1, 1

[4] Anh Hoang, ‘John Maynard Keynes: The Essential Truth Of The Great Depression’ (www.gurufocus.com 2011) <http://www.gurufocus.com/news/148446/john-maynard-keynes-the-essential-truth-of-the-great-depression> accessed 29 March 2013

[5]J M Keynes, ‘The Great Slump Of 1930’ [1930] TGS 1, 1.

[6] A Review Of Keynesian Theory’ (http://www.huppi.com ) <http://www.huppi.com//kangaroo/Keynesianism.htm> accessed 30 March 2013

[7] J M Keynes, ‘The Great Slump Of 1930’ [1930] TGS 1, 1.

[8] J M Keynes, The General Theory of Employment, Interest, and Money(1st, Harcourt, Brace and Company, Macmillan Cambridge University Press, for Royal Economic Society 1936) 21

[9] H J Sherman, E K Hunt, R F Nesiba, P A O’Hara, B Wiens-Tuers, ‘Keynesian Economics And The Great Depression’ in (eds), Economics : An Introduction to Traditional And Progressive Views (7th, M E Sharpe, Library of Congress, United States of America 2008).

[10] J M Keynes, The General Theory of Employment, Interest, and Money(1st, Harcourt, Brace and Company, Macmillan Cambridge University Press, for Royal Economic Society 1936) 27.

[11] H J Sherman, E K Hunt, R F Nesiba, P A O’Hara, B Wiens-Tuers, ‘Keynesian Economics And The Great Depression’ in (eds), Economics : An Introduction to Traditional And Progressive Views (7th, M E Sharpe, Library of Congress, United States of America 2008).

[12] Ibid.

[13] J M Keynes, The General Theory of Employment, Interest, and Money(1st, Harcourt, Brace and Company, Macmillan Cambridge University Press, for Royal Economic Society 1936), 23.

[14] A Review Of Keynesian Theory’ (http://www.huppi.com ) <http://www.huppi.com//kangaroo/Keynesianism.htm> accessed 30 March 2013.

[15] H J Sherman, E K Hunt, R F Nesiba, P A O’Hara, B Wiens-Tuers, ‘Keynesian Economics And The Great Depression’ in (eds), Economics : An Introduction to Traditional And Progressive Views (7th, M E Sharpe, Library of Congress, United States of America 2008).

[16] J M Keynes, ‘The Great Slump Of 1930’ [1930] TGS 1, 1.

[17] A Review Of Keynesian Theory’ (http://www.huppi.com ) <http://www.huppi.com//kangaroo/Keynesianism.htm> accessed 31 March 2013.

[18] J M Keynes, ‘The World’s Economic Outlook’ [1932] WEO 1, 1

[19] J M Keynes, The General Theory of Employment, Interest, and Money(1st, Harcourt, Brace and Company, Macmillan Cambridge University Press, for Royal Economic Society 1936), 68.

[20] D M Kennedy, ‘The Great Depression and World War II, 1929-1945’ (http://www.gilderlehrman.org ) <http://www.gilderlehrman.org/history-by-era/essays/great-depression-and-world-war-ii-1929-1945> accessed 5 April 2013

[21] D M Kennedy, ‘The Great Depression and World War II, 1929-1945’ (http://www.gilderlehrman.org ) <http://www.gilderlehrman.org/history-by-era/essays/great-depression-and-world-war-ii-1929-1945> accessed 5 April 2013

[22] A Carden, ‘The Great Depression and World War II’ (http://www.fee.org 2009) <http://www.fee.org/the_freeman/detail/the-great-depression-and-world-war-ii#axzz2Pt6xfdrp> accessed 6 April 2013

[23] J Powell, ‘Why Was So Much New Deal Relief and Public Works Money Channeled Away from the Poorest People?’ in W Hughes (eds), FDR’s Folly: How Roosevelt and His New Deal Prolonged the Great Depression(1st, Crown Publishing Group, 2003).

[24] J Powell, ‘Why Did New Dealers Make Everything Cost More in the Depression?’ in W Hughes (eds), FDR’s Folly: How Roosevelt and His New Deal Prolonged the Great Depression(1st, Crown Publishing Group, 2003).

[25] H J Sherman, E K Hunt, R F Nesiba, P A O’Hara, B Wiens-Tuers, ‘Keynesian Economics And The Great Depression’ in (eds), Economics : An Introduction to Traditional And Progressive Views (7th, M E Sharpe, Library of Congress, United States of America 2008).

[26] J M Keynes, The General Theory of Employment, Interest, and Money(1st, Harcourt, Brace and Company, Macmillan Cambridge University Press, for Royal Economic Society 1936), 11.

[27] Ibid.

[28] A Benassy-Quere, B Coeure, P Jacquet, J Pisani-Ferry, Economic Policy : Theory And Practice (1st, Oxford University Press, Oxford 2010) 181.

[29] J M Keynes, The General Theory of Employment, Interest, and Money(1st, Harcourt, Brace and Company, Macmillan Cambridge University Press, for Royal Economic Society 1936), 12.

[30] Ibid.

[31] Ibid.

[32] Ibid.

[33] The Stock Market Crash of 1929′ (http://www3.nd.edu/ ) <http://www3.nd.edu/~jstiver/FIN462/US%20Market%20Crashes.pdf> accessed 2 April 2013

[34] Ibid.

[35] The Stock Market Crash of 1929′ (http://www3.nd.edu/ ) <http://www3.nd.edu/~jstiver/FIN462/US%20Market%20Crashes.pdf> accessed 2 April 2013

[36] Ibid.

[37] Ibid.

[38] B Wattenberg, ‘The First Measured Century : Stock Market Crash’ (http://www.pbs.org ) <http://www.pbs.org/fmc/timeline/estockmktcrash.htm> accessed 3 April 2013

[39] Ibid.

[40] Ibid.

[41] Ibid.

[42] R Higgs, ‘Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War’ in (eds), Depression, War and Cold War (1st, Oxford University Press, Inc, Oxford 2006).

[43] R Higgs, ‘Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War’ in (eds), Depression, War and Cold War (1st, Oxford University Press, Inc, Oxford 2006).

[44] Ibid.

[45] D M Kennedy, ‘The Great Depression and World War II, 1929-1945’ (http://www.gilderlehrman.org ) <http://www.gilderlehrman.org/history-by-era/essays/great-depression-and-world-war-ii-1929-1945> accessed 5 April 2013

[46] R Higgs, ‘Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War’ in (eds), Depression, War and Cold War (1st, Oxford University Press, Inc, Oxford 2006).

[47] Ibid.

[48] Ibid.

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