REVIEW PART 2: Mr. Stewart’s 4(.5) Causes of the Great Depression

Hey guys, this is just a continuation of my first review post (in which I discussed the Roaring Twenties: http://ushaplahs2013.blogspot.com/2013/12/review-part-1-roaring-twenties.html) Hope this helps. Also, be sure to check out Ashwin’s post http://ushaplahs2013.blogspot.com/2013/11/some-causes-of-great-depression.html and Ian’s post http://ushaplahs2013.blogspot.com/2013/12/causes-of-great-depression-many.html about causes of the Great Depression. Feel free to add on to any of the points that I talk about here.

Mr. Stewart outlined 4(.5) main causes of the Great Depression:

1. Lack of Diversification in the American Economy

At the time, there were 2 driving forces of the growing American economy: the automobile industry and the construction industry.

- Construction: With the growth of cities and urban areas, construction of such things as buildings, roads, bridges, houses, etc. was necessary.

- Automobiles: Henry Fords’ revolutionary T-Model, assembly lines and mass production of automobiles, came to be the second of America’s big industries at the time.

It is important to understand that these two industries, on top of driving most of the country’s economic activity, also affected other, smaller industries. As such, their performance affected other industries’ performances as well. The industries of the materials and resources that go into construction and cars: electricity, steel, wood, fuel, rubber, etc., were also brought down when these two main industries suffered.

When symptoms of the Great Depression began emerging and these two industries were badly hit, (construction expenditures decreased from $11 billion to $9 billion from 1926-1929 and car sales fell by 33% in the first 9 months of 1929), these smaller industries were also hit hard.  

As a whole, the entire economy was suffering because no other area of the economy could compensate for the fall of the economy's two biggest sectors.

Leading up to the Great Depression, things in America were running smoothly; business was booming. But at some point, the aforementioned industries become oversaturated (they produced too much of their product!) In order to maximize profits, the two industries almost had to guess how demand would play out in future years and gambled on things. Expecting a growth in demand, they hurried to build their respective products (cars/buildings), in anticipation of customers solving the problem of this oversaturation. This was not the case. When oversaturation began cutting substantially into a companies’ profit, they began cutting employees to compensate for the loss of money. Not only were two biggest industries laying off workers in droves to save money, all of the smaller industries under them must have had to as well.

To summarize: Symptoms of Great Depression in addition to oversaturation → 2 big industries hit hard means all smaller industries suffer as well → 2 big industries and smaller industries lay off workers → Downwards spiral of American economy

2. Maldistribution of Wealth

At the time, similar to how it is now, there was a maldistribution of the wealth, meaning there was a top 2% of society (probably people like the robber barons), a small middle class (~30--40%) and a lower class of around 60%. This distribution of wealth augmented the problems of the Great Depression greatly when they rolled around.

The American economic model at the time was set up in such a way that big businesses did not pass off their wealth and profits to consumers. Only the top 2% was getting rich, while the rest of the people lived in near poverty (just so you get an idea of things: by 1929, over ½ families lived at below subsistence level, the level at which adequate life is barely supported).

As you can imagine, the problem worsened when many in the already suffering bottom 60% of Americans were laid off (see why they were laid off in first point). So, people had even less money, considering they had no jobs anymore.

With 2% of Americans at the top and 60% at the bottom, the middle class represented a modest 38% (around 30-40). The disadvantages of having a small middle class became visible when the stock market crash happened. When the stock market began to crash, the upper 2%, in an effort to minimize money loss, was spooked and stopped investing. The bottom 60%, being in the financial rut that it was in, did not invest either. This left the onus of establishing balance on the middle class: the urban professionals of American society. But, America, with its small middle class, couldn’t compensate for both the upper and lower classes not investing in stock. There was too much concentration at the top, too much poverty, and not enough middle class for the economy to bounce back from a decline in investment in stock. This was the maldistribution of wealth.
To summarize: 2% rich, 38% middle class, and 60% lower class → nobody to assume burden of stock market crash and majority of people getting poorer while minority gets richer.

3. Credit Structure of the Economy

The early 1900s saw a rise in the popularity of the use of credit. People began using credit to purchase everything-furniture, cars, and even eventually, stock. According to the video that we watched in class, people in the 1920s purchased 75% of their household items purely on credit.

Banks and investment groups who loaned the money to these people charged interest on their credit, and this system works as long as enough people borrowing money from said banks and investment groups can pay back their money. Problems arise when the people fail to pay back their loaned money.

Around this time, people began borrowing money to buy stock, also known as buying on margin.

Stock brokers at the time offered people stocks for much less (as low as 10%). They offered such deals because they understood that as long their stock went up in value, they could sell the stock at any point and still make a profit. As soon as stocks went down in value, however,

these brokers would ask the people to whom they had loaned money to sell the stock, just to make sure they didn’t lose money. The stock acted as collateral to counterbalance debt.

This system works perfectly, until the price of the stock drops. When stock drops, then numerous parties are affected. The buyer, the seller of stock, and the company are all, as Mr. Stewart said, “out”. During the Great Depression, people had bought stocks on margin, meaning that when the stock market crashed, they could neither sell their quickly depreciating stock (nobody wanted to buy it) nor pay back stock brokers. Everyone seemed to realize that stocks weren’t worth the value that they had been advertised to be; they were inflated.

4/4.5. International Trade and International Debt

International Trade

While the American economy was suffering internally, things weren’t doing too well externally, either. Demand for American products internationally (specifically Europe) was in decline.

Initially, European nations hadn’t recovered from the destruction of WWI and the demand for American products was high. But by the 1920s, as many European nations began to recover, there was a decline in demand for American products because these nations were capable of  making their own products. Still, other European nations hadn’t recovered as quickly, and couldn’t afford American products altogether. With some European nations not needing American products and others incapable of buying American products, the general trend for international trade for the U.S. was downwards.

This problem was further augmented because of tariffs added to American products in order to protect domestic products. For example, the Hawley-Smoot Tariff hiked up prices of American products by 60%. These American tariffs were with a set of European tariffs on their products. Trade was hurt even more.

To summarize: Recovering European nations and other European nations who can’t afford American products and tariffs placed on American products → Less demand for American products abroad, less trade, bad for economy

International Debt

The international debt triangle that we saw in class can be explained as follows:

The Allies, owing the U.S. money, turned to the war reparations that were outlined in the Treaty of Versailles that Germany was supposed to pay them. As the Allies demanded money from Germany, Germany turned to the U.S. loans to pay back the Allies, who had to pay back the U.S. This essentially created the triangle (as we saw in Mr. Stewart’s diagrams).

The problem arose when the Great Depression hit the U.S. With U.S. banks in trouble (they made too many loans and were in debt; people couldn’t pay them back because of credit, etc. etc.), they didn’t want to loan Germany money any more. This disrupted the flow of money in the triangle: Germany now couldn’t pay back the Allies, who, by consequence, couldn’t pay back the U.S.

IN THE END

In American history, panics are many. Basically, what set the Great Depression apart from other panics was that it was essentially a synthesis of every single cause of a panic possible.

Sources: Mr. Stewart

Video Documentaries in class