Great Depression: a Lesson for all Economists
The international financial crisis in the years 1929-1933 is undoubtedly the most important crisis, the longest and most serious consequences of all that took place in history. This crisis followed a period of prosperity and growth.
Overproduction crisis of the years 1929-1933 was manifested in the financial and banking activities affected the level of industrial production, commodity prices, industrial and agricultural living standards fell dramatically and unemployment and poverty reached an impressive number of people. “For the United States and Britain, the event was more serious than war itself”.
Between 1920 and 1929, the market economy of the developed capitalist countries still remained under the influence of prewar economic phenomena and realities generated by the first great global conflagration. Some of the phenomena characteristic of those years:
- Massive demand for food, consumer goods, industrial equipment, raw materials for the immediate needs of the population and economic reconstruction.In America, this massive increase in the demand of goods and services developed and standard of living increased. In that time, the Americans from middle class began to be able to afford electricity, automobiles and housing. Thus, for example, the demand for cars has increased from 9 million in 1920 to 23 million in 1929 and electricity consumption has doubled in this period. Americans bought everything from cars, radios and vacuum cleaners to cinema tickets and tours in Europe. From 1917 to 1931, the demand for goods and services increased by 45%. Also it can be seen that the demand for durable goods has almost doubled over the same period. Based on the model of supply and demand, in the period 1921-1929 production almost doubled. During 1921-1929, FED applied a tight monetary policy that led to deflation. Thus, prices of intermediate goods declined, between 1922 and 1929, at a rate of 0.9% per year and consumer prices rose in the same period at a rate of 0.4% per year.
- An increasing number of investors.Economic growth in that period offered mankind reasons of trust and optimism. Social stability and prosperity seemed to be installed for long. For months, before the stock market crashed, the U.S. was gripped by a frenzy of purchasing all over the country. The brokerage offices filled every day people hungry for profit. “Payment rate” allowed all employees to buy shares on credit. The New York Stock Exchange-NYSE trading volume rose from 433 million in debt securities 1925 to 757000000 in 1929. Thus, the investment in stock exchange became more profitable than depositing money in banks. Obviously, not everyone can invest on the stock market, but only a minority, whereas 0.1% of the U.S. population owned 34% of the total savings. Therefore, 0.1% of the population, banks and companies could afford to speculate on the stock exchange. Population savings banks and firms heavily invested in corporate bonds, speculating on the stock market in the short term based on getting a better income from high yield securities than bank interest. To stop the growth hedge the FED (Federal Bank) decided to increase the discount rate / interest at 6%.
- The cheap money policy. During this period, the banking system provided loans to Americans much easier than before and it is likely that, in addition to cars and houses, many of those that took loans invested some money in the stock market.
- Investment companies created overproduction. In 1925, the industry manifested early signs of overproduction (growth stocks). However, in anticipation of increased demand, the company management decided to reinvest profits in new production capacities, increasing the already existing problem. New workers were hired and they began to buy goods and services on credit, thereby increasing production and stimulating an increase in share prices.
- Lack of regulation concerning the business of stock. At that time, the legal framework was extremely permissive and therefore, companies could increase their capital by issuing new shares that were sold to investors. Trading “margin” exploded and investors bought stocks on margin (paying only a fraction of the value) in a context of a continuing uptrend, hoping that they will sell them a few months later at a higher price and earn the difference. This led to a giant pyramid scheme since most of the money that was invested in the stock didn’t exist.
We are talking about the Great Depression because it was manifested in all areas of economic sectors with the same virulence and included all countries. The only countries that were exceptions were the USSR and Sweden. In the USSR, the crisis were less visible due to a socialist planning, and in Sweden the economic effects were attenuated due to a very efficient system of social security.Regarding the causes of it, we can say that the crisis in 1929-1930 appeared because of increasing interest rates and the application of protectionist measures that led to the contraction of international trade. So, the crisis arose because of the type of interventionist measures applied at inappropriate times and were based on erroneous assessments. In addition, the collaboration between different public American organizations was poor.
On the other hand should be noted that the political consequences of the crisis of 1929-1933 were stronger and more harmful to humanity than its economic consequences. The impact of the political crisis was particularly harsh in West and Central Europe. In Germany it led to the Nazi dictatorship, in France and England led to the disintegration of the executive and ministerial instability. Political fears have prevented the essential economic cooperation in order to recover and restore confidence.
In the current crisis, the question is whether we can compare the causes and effects of the crisis generated in the 1929-1933 period. With regard to the opinions of specialists, answer to this question can be divided into two categories. Thus, some believe that there are some similarities, because the crisis was caused by excessive speculation in financial assets, especially equities and real estate (subprime loans triggered the current economic crisis), assets whose price completely uncontrolled increased in the last 10 years and now when their price is close to normal values, we find that global wealth shrank by 30,000 billion. In addition, it is clear that governments and the various regulatory institutions have not kept pace with the times and the existing legislative framework in some areas is completely outdated.
On the other hand, there are differences, because now there is more wealth, global economic situation is incomparably better than it was 90 years ago and governments have tried to fight this crisis.