Monday, September 19, 2011

The Economic Depression of 1929

While we are in the midst of this horrendous recession, it would be of value to compare the causes of our current economic doldrums with the convergence of factors that brought on the Great Depression of 1929.  Although the specific conditions and circumstances may vary, the similarities are striking.

The economic depression of 1929 catapulted the national economy into a devastating tailspin from the seeming prosperity of the 1920s.  The rapid decline occurred as a direct result of many factors that were all interconnected.  The so-called Great Depression lasted from 1929 through 1938.

The precipitous decline that so defined the Great Depression began on what is referred to as Black Tuesday – October 29 1929 - when 16 million shares were traded and the industrial stock index dropped 43 points negating all the gains made over the previous twelve months.  By the middle of November of that year, the market had lost a third of its entire value or 40% of all the stock that was traded on the Exchange.  The reasons for this sudden and calamitous event were multi-faceted.

The seeming prosperity that was a hallmark of the 1920s was, in fact, not representative of the majority of Americans.  Following the hard times imposed by World War I, economic production markedly increased, especially in regards to automobiles, home appliances and construction.  In addition, overseas investment doubled to 7.5 billion dollars by 1929.  Although consumer spending increased markedly during this period, individuals were buying beyond their means, placing themselves in a precarious position regarding personal indebtedness.

In addition, the distribution of wealth was skewed markedly to the wealthy.  In 1929, the top 0.1% of American households collectively had as much wealth as 42% of the population and possessed one-third of all the savings.  As a matter of fact, it has been estimated that 80% of the population had no savings at all.

By 1929, investments in the stock market increased far more than any other indicator, and, more to the point, outstripped actual production or sales of manufactured goods.  One aspect of this marked increase in transactions on the stock exchange was the practice of "buying on margin."  Using this approach, an investor determined to purchase $1,000 worth of stock valued at $10 per share, was legally enabled to pay his broker as little as 10% of the actual worth of the stock or $100.  This practice was common in the 1920s; because, the value of stock seemed to be always increasing.  With this in mind, the investor could then wait until the value of the stock rose, sell it at a significant profit, pay his broker and pocket the difference.  This kind of gambling persisted; until, the inevitable happened – the bubble burst.  To some extent, the unraveling began in Great Britain when the country raised its interest rates to lure back domestic investors.  Aware of the significance of this policy change, foreign and U.S. investors began dumping U.S. stocks.

Following Black Tuesday, the economic situation worsened as the nation inexorably slid into depression.  Within three years, the so-called industrial index – a quantitative measure of the performance of shares in major industries such as automobiles – dropped from 452 in September of 1929 to 58 by July of 1932.  It must be remembered that it has been estimated that only 2.5% of the entire population actually invested in the stock market; therefore the reason for the depression must have resided elsewhere.  The causes for the depression itself can be explained by the following factors:


·         Decline in Industrial Production – Much of the economic growth during this era can be directly related to two major industries, the production of automobiles and construction.  By the end of the 20s, both of these facets of the economy were in decline.

·         Poverty and Personal Indebtedness – Poverty was, in fact, widespread and personal debt was high as well.  The wages of individual workers had only increased by 8%; whereas, the productivity of the individual worker increased by an estimated 32%.  These data translated into the economic reality that individuals could not afford to purchase the products of industrial output.  This convergence of factors inevitably led to mass unemployment.

·         Bank Failures - Since banks were heavily engaged in speculation on the stock market and since the banks were using the savings of their customers for these questionable investments, they were unable to effectively deal with rush on the banks when people wished to withdraw their savings en masse.  As a result, thousands of banks failed and many lost their life savings.


Adding to the economic deterioration as outlined above, the Dust Bowl of the 1930's had a devastating impact on farmers of the Great Plains.  After years of farming without adequate rotation of crops, an unusual period of extreme drought together with harsh weather conditions resulted in the topsoil being literally blown away.  Between 1933 and 1938, three to four inches of topsoil were lost to the winds and created what was referred to as "Black Blizzards."  As a result, 500,000 residents of the Great Plains became homeless and 2.5 million moved out of the region by 1940.


The government's response to this deepening crisis was inadequate.  Although President Herbert Hoover felt compassion for the millions who were suffering and although he attempted to use some of the government's resources to address the issue – he requested 2.25 billion dollars from the Congress for public works progress - his political philosophy constrained his efforts in this regard.  He felt strongly that the government should not be involved in direct relief by providing resources to those or were poor, starving and unemployed.  He felt that, "It is not the function of the government to relieve individuals of their responsibilities to their neighbors, or to relieve private institutions of their responsibilities to the public."  In the general election of 1932, the people chose Franklin Delano Roosevelt as their next president, who promised a New Deal.  The fundamental focus of the New Deal was threefold – the so-called 3 Rs – relief, recovery and reform.  In order to accomplish these ambitious goals, fifteen major pieces of legislation were submitted to Congress from spring to early summer.


In spite of all these efforts, it was the onset of World War II that effectively brought the country out of the Great Depression.  

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