GREAT DEPRESSION

Worldwide economic downturn that began in 1929 and lasted until about 1939 was the longest and most severe depression ever experienced by the industrialized Western world. Although the Depression originated in the United States, it resulted in drastic declines in output, severe unemployment, and acute deflation in almost every country of the globe. But its social and cultural effects were no less staggering, especially in the United States, where the Great Depression ranks second only to the Civil War as the gravest crisis in American history.
 

Economic history

The timing and severity of the Great Depression varied substantially across countries. The Depression was particularly long and severe in the United States and Europe; it was milder in Japan and much of Latin America. Perhaps not surprisingly, the worst depression ever experienced stemmed from a multitude of causes.
Declines in consumer demand, financial panics, and misguided government policies caused economic output to fall in the United States. The gold standard, which linked nearly all the countries of the world in a network of fixed currency exchange rates, played a key role in transmitting the American downturn to other countries.
The recovery from the Great Depression was spurred largely by the abandonment of the gold standard and the ensuing monetary expansion. The Great Depression brought about fundamental changes in economic institutions, macroeconomic policy, and economic theory.
 

Timing and severity

In the United States, the Great Depression began in the summer of 1929. The downturn became markedly worse in late 1929 and continued until early 1933. Real output and prices fell sharply. Between the peak and the trough of the downturn, industrial production in the United States declined 47 percent and real GDP fell 30 percent. The wholesale price index declined 33 percent (such declines in the price level are referred to as “deflation”). The unemployment rate exceeded 20 percent at its highest point.
GREAT BRITAIN struggled with low growth and recession during most of the second half of the 1920s, due largely to its decision in 1925 to return to the gold standard with an overvalued pound. Britain did not slip into severe depression, however, until early 1930, and the peak-to-trough decline in industrial production was roughly one-third that of the United States.
FRANCE also experienced a relatively short downturn in the early 1930s. The French recovery in 1932 and 1933, however, was short-lived. French industrial production and prices both fell substantially between 1933 and 1936.
GERMANY’s economy slipped into a downturn early in 1928 and then stabilized before turning down again in the third quarter of 1929. The decline in German industrial production was roughly equal to that in the United States.
A number of countries in LATIN AMERICA slipped into depression in late 1928 and early 1929, slightly before the U.S. decline in output. While some less developed countries experienced severe depressions, others, such as ARGENTINA and BRAZIL, experienced comparatively mild downturns.
 

The depression in JAPAN started relatively late (in early 1930) and was, by comparison, mild. Because of the greater flexibility of the Japanese price structure, deflation in Japan was unusually rapid in 1930 and 1931. This rapid deflation may have helped to keep the decline in Japanese production relatively mild.
 

The U.S. recovery began in the spring of 1933. Output grew rapidly in the mid-1930s: Real GDP rose at an average rate of 9 percent per year between 1933 and 1937. In 1937–38 the United States suffered another severe downturn, but after mid-1938 the American economy grew even more rapidly than in the mid-1930s. U.S. output finally returned to its long-run trend level in 1942.
Recovery in the rest of the world varied greatly. The British economy stopped declining soon after Britain’s abandonment of the gold standard in September 1931, though genuine recovery did not begin until the end of 1932. The economies of a number of Latin American countries began to strengthen in late 1931 and early 1932. Germany and Japan both began to recover in the fall of 1932. Canada and many smaller European countries started to revive at about the same time as the United States, early in 1933. On the other hand, France, which experienced severe depression later than most countries, did not firmly enter the recovery phase until 1938.
 

Causes of the great depression

The fundamental cause of the Great Depression in the United States was a decline in spending (sometimes referred to as aggregate demand), which led to a decline in production as manufacturers and merchandisers noticed an unintended rise in inventories.
The sources of the contraction in spending in the United States varied over the course of the Depression, but they cumulated into a monumental decline in aggregate demand. The American decline was transmitted to the rest of the world largely through the gold standard.
However, a variety of other factors also influenced the downturn in various countries.
 

Economic aftermath of WWI

Unbalanced Cash Flow: It basically stemmed from the nature of American dominance of the world economy in the 1920's compared to previous British dominance in the 1800's. The British had to maintain a fairly balanced cash flow in world trade as they had to buy raw materials with much of the trade surplus. This prevented too severe a drain of cash from other countries, thus assuring Britain more stable markets. In contrast, the United States was not only an industrial power selling manufactured goods in markets; it also had its own vast natural resources. This created an unbalanced cash flow from the rest of the world to the United States. European nations, still recovering from the war, needed loans, which they got from American banks. This sent even more money to the United States in the form of repayments and interest, just making an even more unbalanced cash flow.
The second problem had to do with Europe's recovery from WWI. Wartime expenditure had reduced the countries of Europe to a state of heavy debt. European industries did revive to their old pre-war levels of production by 1925, but they failed to reclaim their old markets from the United States or create new markets to compensate for the losses. As a result, the intense economic competition between nations that had largely caused World War I continued after it. Therefore, nations still maintained high tariffs, which raised prices, cut world trade, and further weakened the world economy.
Finally there was an agricultural crisis in the USA. This was the result of dramatic expansion of farmland in order to meet the food demands of the European countries during the war. However, European agricultural production revived after the war, causing overproduction. Agricultural prices plummeted, and American farmers went into debt, many of them losing their farms when they were unable to maintain interest payments on their newly expanded farms. Although America's industries seemed to be thriving, its agricultural sector, still a large part of its population and economy, was in trouble.
 

Stock market crash

The onset of Great Depression was caused by a crash in American stock market. There was a huge cash surplus in American economy due to unbalanced trade with world. In the US huge amounts of this cash surplus was in invested in the stock market. Investors only had to pay just 10% cash for their stocks as Banks financed the balance at 10-15% interest. Stock prices had inflated valuations which was dangerous for economy. In October 1929, the market crashed, a case of panic psychology running wildly out of control. Investors were in debt to the banks causing more panic selling and by November 13, the stock market had lost half of its value.
This spilled over into the rest of the American economy, which led to a decline in investment and buying. Therefore, production was cut, which caused unemployment. Prices of goods fell causing deflation in market. Outstanding debts became heavier, because prices and incomes fell by 20–50% but the debts remained at the same amount. This led to the collapse of 5000 American banks, many of which had over-invested in the stock market. These banks called in loans from Europe, whose economies were already unstable and overly dependent on American loans. The result was a worldwide depression spreading from America and Europe to the rest of the world that was tied into their economies.
 

Banking panics and monetary contraction

The next blow to aggregate demand occurred in the fall of 1930, when the first of four waves of banking panics gripped the United States. A banking panic arises when many depositors lose confidence in the solvency of banks and simultaneously demand their deposits be paid to them in cash. Banks, which typically hold only a fraction of deposits as cash reserves, must liquidate loans in order to raise the required cash. This process of hasty liquidation can cause even a previously solvent bank to fail.
The United States experienced widespread banking panics in the fall of 1930, the spring of 1931, the fall of 1931, and the fall of 1932. The final wave of panics continued through the winter of 1933 and culminated with the national “bank holiday” declared by President Franklin Roosevelt on March 6, 1933. The bank holiday closed all banks, permitting them to reopen only after being deemed solvent by government inspectors. The panics took a severe toll on the American banking system.
The panics surely exacerbated the decline in spending by generating pessimism and a loss of confidence. Furthermore, the failure of so many banks disrupted lending, thereby reducing the funds available to finance investment.
 

The gold standard

Some economists believe that the Federal Reserve allowed or caused the huge declines in the American money supply partly to preserve the gold standard. Under the gold standard, each country set a value of its currency in terms of gold and took monetary actions to defend the fixed price.
Under the gold standard, imbalances in trade or asset flows gave rise to international gold flows. Maintaining the international gold standard, in essence, required a massive monetary contraction throughout the world to match the one occurring in the United States. The result was a decline in output and prices in countries throughout the world that also nearly matched the downturn in the United States.
 

International lending and trade

Some scholars stress the importance of other international linkages. Foreign lending to Germany and Latin America had expanded greatly in the mid-1920s. U.S. lending abroad then fell in 1928 and 1929 as a result of high interest rates and the booming stock market in the United States. This reduction in foreign lending may have led to further credit contractions and declines in output in borrower countries. The effects of reduced foreign lending may explain why the economies of Germany, Argentina, and Brazil turned down before the Great Depression began in the United States.
The 1930 enactment of the SMOOT-HAWLEY TARIFF in the United States and the worldwide rise in protectionist trade policies created other complications. The Smoot-Hawley tariff was meant to boost farm incomes by reducing foreign competition in agricultural products . But other countries followed suit, both in retaliation and in an attempt to force a correction of trade imbalances.
 

Sources of Recovery

Given the key roles of monetary contraction and the gold standard in causing the Great Depression, it is not surprising that currency devaluations and monetary expansion became the leading sources of recovery throughout the world.
There is a notable correlation between the time countries abandoned the gold standard (or devalued their currencies substantially) and a renewed growth in their output. For example, Britain, which was forced off the gold standard in September 1931, recovered relatively early, while the United States, which did not effectively devalue its currency until 1933, recovered substantially later. In contrast, the “Gold Bloc” countries of Belgium and France, which were particularly wedded to the gold standard and slow to devalue, still had industrial production in 1935 well below its 1929 level.
Devaluation, however, did not increase output directly. Rather, it allowed countries to expand their money supplies without concern about gold movements and exchange rates. Countries that took greater advantage of this freedom saw greater recovery.
Worldwide monetary expansion stimulated spending by lowering interest rates and making credit more widely available. It also created expectations of inflation, rather than deflation, and so made potential borrowers more confident.
Fiscal policy played a relatively small role in stimulating recovery in the United States. Indeed, the Revenue Act of 1932 increased American tax rates greatly in an attempt to balance the federal budget, and by doing so dealt another contractionary blow to the economy by further discouraging spending.
Franklin Roosevelt’s New Deal, initiated in early 1933, did include a number of new federal programs aimed at generating recovery. For example, the WORKS PROGRESS ADMINISTRATION (WPA) hired the unemployed to work on government building projects, and the AGRICULTURAL ADJUSTMENT ADMINISTRATION (AAA) gave large payments to farmers. However, the actual increases in government spending and the government budget deficit were small relative to the size of the economy.
 

New Deal

The "New Deal" has become the accepted name for the policies followed by the Roosevelt administrations during the 1930s. This statement by Roosevelt during the election campaign of 1932 caught the attention of the American public.
Roosevelt had three basic aims which directed his actions:

• Help the victims of the Depression
• Encourage economic recovery
• Reform the economic system

To achieve these objectives, Roosevelt decided that direct action and intervention by the federal government would be necessary. The days of laissez-faire, of the government doing as little as possible, were over.
‘Alphabet agencies’ were new government departments set up to implement Roosevelt's policies and were the best known aspects of the New Deal.
Federal Emergency Relief Administration (FERA). This helped the poor in a number of basic ways, such as giving clothing grants and setting up soup kitchens for the poor.
Agricultural Adjustment Act (AAA). This tried to help farmers by controlling farm production and stabilising prices. It was an attempt to end the over-production and falling agricultural prices that had crippled American farmers.
National Recovery Administration (NRA). This tried to help industry and factory workers by increasing wages and improving hours and conditions.
Public Works Administration (PWA). This created jobs by paying unemployed people to build schools, bridges and dams. This was replaced by the Works Progress Administration in 1935.
Civilian Conservation Corps (CCC). Similar to the PWA, this department provided jobs to large numbers of young men in conservation schemes in the countryside.
Tennessee Valley Authority (TVA). This scheme brought hydro-electric power to seven states in the Tennessee Valley, one of the worst affected areas of the country. Dams and power-plants were built, creating many jobs.
In addition to this, Roosevelt's administration carried out major reforms to the American Stock Exchange and the banking system. There were two key elements in Roosevelt's plans to repair the economic damage caused by the Wall Street Crash. These were, ending the practices of cheap credit from banks and irresponsible share trading on the Stock Exchange.
 

Did the New Deal work for America?

The United States recovered from the Depression of the 1930s. Roosevelt's New Deal helped restore confidence to American companies and citizens. The New Deal identified problems, such as banking irregularities, and tried to address them. Roosevelt's public work schemes also helped to ease the burden of unemployment. As the Depression gathered pace after 1929, Americans had lost confidence in their government's ability to deliver prosperity. The New Deal helped to restore that confidence. Roosevelt's public image was one of strength and assurance, of a powerful and reassuring leader.
Unemployment: Initially the unemployment numbers decreased through the work of the "Alphabet" agencies, which helped in alleviating poverty. Unemployment increased again in 1938 after Roosevelt reduced government spending. It only began to fall steeply again in 1939 when the USA began to build up its armaments in cause of war. This led to huge increases in jobs in industry.
Relief from poverty: The many relief schemes provided jobs and support for millions of people.
Public works: Under the New Deal, the country gained from public works projects - dams, roads, airfields, schools, bridges, reforestation schemes, and similar projects which brought lasting benefits to local communities.
The banking system: Increased bank regulation helped restore public confidence in them and helped to support steady and sustained economic growth.
Political effects: The New Deal restored the confidence of the American people in their government. They retained their belief in democracy at a time when, in Europe, democracy was facing major challenges from far-right, anti-democratic politics.
Although the actual amount of success of the New Deal can be argued over, Roosevelt's measures had at least held together the economy of the USA and provided relief to the victims of the Depression. Also, while some European nations turned to extreme totalitarian political systems as a response to the Depression, Roosevelt had preserved the democratic tradition of America.
Realistically, the economy of the USA only fully recovered with the outbreak of World War II. With European industry and agriculture shattered by the conflict, American factories and farmers reaped the benefits. The need to raise a US army also solved the unemployment crisis.
 

Economic impact of the Depression

The most obvious economic impact of the Great Depression was human suffering. In a short period of time world output and standards of living dropped precipitously. As much as one-fourth of the labour force in industrialized countries was unable to find work in the early 1930s.
While conditions began to improve by the mid-1930s, total recovery was not accomplished until the end of the decade. The Depression and the policy response also changed the world economy in crucial ways. The Great Depression hastened, if not caused, the end of the international gold standard.
Although a system of fixed currency exchange rates was reinstated after World War II under the BRETTON WOODS SYSTEM, the economies of the world never embraced that system with the conviction and fervour they had brought to the gold standard. By 1973, fixed exchange rates were abandoned in favour of floating rates.
Both labour unions and the welfare state expanded substantially during the 1930s. In the United States, union membership more than doubled between 1930 and 1940. This trend was stimulated both by the severe unemployment of the 1930s and the passage of the NATIONAL LABOR RELATIONS (WAGNER) ACT (1935), which encouraged collective bargaining.
The United States established unemployment compensation and old age and survivors’ insurance through the SOCIAL SECURITY ACT (1935), which was passed in response to the hardships of the 1930s.
THE BANKING ACT OF 1933 (ALSO KNOWN AS THE GLASS-STEAGALL ACT) established deposit insurance in the United States and prohibited banks from underwriting or dealing in securities. Deposit insurance, which did not become common worldwide until after World War II, effectively eliminated banking panics as an exacerbating factor in recessions in the United States after 1933.
The Depression also played a crucial role in the development of macroeconomic policies intended to temper economic downturns and upturns. The central role of reduced spending and monetary contraction in the Depression led British economist John Maynard Keynes to develop the ideas in his General Theory of Employment, Interest, and Money (1936). Keynes’s theory suggested that increases in government spending, tax cuts, and monetary expansion could be used to counteract depressions. This insight, combined with a growing consensus that government should try to stabilize employment, has led to much more activist policy since the 1930s. Legislatures and central banks throughout the world now routinely attempt to prevent or moderate recessions.
 

Great Depression and India

In the nineteenth century, colonial India had become an exporter of agricultural goods and importer of manufactures. The great depression immediately affected Indian trade. British India adopted a protective trade policy which, though beneficial to the United Kingdom, caused great damage to the Indian economy.
India's exports and imports nearly halved between 1928 and 1934. Due to the drastic collapse of international trade and the very little revenue obtained for it, India could only pay off her home charges by selling off her gold reserves. The international financial crisis combined with detrimental policies adopted by the Government of India resulted in the soaring prices of commodities.
Peasants and farmers suffered more than urban dwellers. As international prices crashed, prices in India also plunged. Between 1928 and 1934, wheat prices in India fell by 50 per cent. Though agricultural prices fell sharply, the colonial government refused to reduce revenue demands. Peasants producing for the world market were the worst hit. Across India, peasants' indebtedness increased.
Farmers who were cultivating food crops had earlier moved over to cash crop cultivation in large numbers to meet the demands of the mills in the United Kingdom. Now, they were crippled as they were unable to sell their products in India due to the high prices; nor could they export the commodities to the United Kingdom which had recently adopted a protective policy prohibiting imports from India.
The discontent of farmers manifested itself in rebellions and riots. The Salt Satyagraha of 1930 was one of the measures undertaken as a response to heavy taxation during the Great Depression.