The Great Depression: Cause & Effect

Presentation on the Great Depression

World War II Lecture

As with any other historical event, the Great Depression had many causes, and multiple effects, some economic, some social, some political, some structural. In this lecture, I will try to review a number of these causes, and to suggest how they helped move much of the world in new directions. In fact, I would like to subtitle this lecture "Modern Solutions to Modern Problems." It is my intent to show not only what happened, but that such phenomena as Nazism, Stalinism, the New Deal, and Japanese Ultranationalism were not unique phenomena that stand out as major errors. Instead, they began as viable solutions to problems that appeared insoluble with ideas that existed at the time – including capitalism and democracy. In fact, democracy was so notoriously inefficient in solving the problems created by the war and the depression that followed that totalitarianism seemed to be not only a solution, but the best and most modern solution – a method to bring maximum productivity to society, and maximum happiness to individuals.

The roots of the Great Depression went as far back as industrial revolution itself – into the 18^th century. Mostly, however, the causes can be found in the First World War and after. To summarize, the Treaty of Versailles put such huge burdens on Germany as to make payment of reparations a practical impossibility. Add to this the fact that all the belligerents had paid for the war with debt, creating a network of debt owed and debt owned, and you already have a recipe for financial collapse. The next part of the equation was the fact that Europe’s war efforts and recovery were supplied by Japan and the United States – the workshops and supermarkets for the world in the 1910’s and 1920’s. Both countries entered the war as net debtor nations, both ended it as net creditor nations. Once European need for Japanese and American goods and food was reduced, however, after reconstruction, both countries discovered they had a serious overproduction and excess labor problem. Finally, in almost no country on the planet was there a system of social welfare, or an economic safety net. Nowhere did the government insure bank deposits, or regulate banks or loans.

To Germany’s credit, it made a massive payment in May, 1921, that dwarfed the total reparations paid in any war in human history to that point. Most of this payment, however, was made in kind, not in cash, as Germany did not have the money, and its industrial and financial infrastructure was in shambles. To pay the debt, the German government printed massive amounts of money. This caused unprecedented deflation in the value of the mark. The 1913 mark had been worth about 4 to the U.S. dollar. By January the exchange rate was 186 to the dollar, and that deflated to 402 per dollar in July of the same year. By December, 1922, a single U.S. dollar, whose purchasing power was only 1/206^th of its own prewar value, was worth 4,000 German marks. The German government found itself unable to continue making reparations payments, and went into default.

In response to the German default, France, which was having difficulties of its own and required the cash Germany was supposed to provide, and which was determined, by making Germany pay every penny, that the German economy would continue in the tank for the foreseeable future, occupied the Ruhr industrial district. Although Belgium participated in this unilateral solution to the reparations payment problem, every other nation that had participated at Versailles in 1918 condemned the act. Never the less, France was determined that Germany should pay. That meant that if the Germans would not, France would take over Ruhr mines and factories and make them pay.

Germany resented this attack on its sovereignty, and to spite the French, paid its workers in the Ruhr district to stay home. This meant that the French had difficulty getting workers to do the mining or man the factories. At best, the French effort broke even. It certainly never made a profit, and never contributed what the French government had hoped it would for the economy. The occupation also proved to be an embarrassment to France, showing it to be the most fearful and shrill voice of self-serving vengeance among the former WWI allies. This act, and France’s constant belligerence concerning Germany, served to isolate it from its former friends, making depression-era aid and understanding that much more difficult to get. For its part Germany, while it maintained its sovereignty over the Ruhr in a heroic, non-violent way, gained no economic benefit from its reaction to the occupation. Rather, the need to pay idle workers for years was another major burden on Germany’s overtaxed financial system and led to even further deflation of the currency.

Following the French occupation of the Ruhr, the German government again turned to printing money in order to make up for the shortfall due to lack of exports from the Ruhr region. By January, 1923 the mark stood at 7200 to the U.S. dollar, and slid from there 1 million to the dollar in August, and 4.2 trillion per dollar in December of 1923. Single mark notes were worth so little that Germans shoveled them into their wood stoves to heat their homes and cook their meals rather than use them for shopping – they had more value as scrap paper than as money. It took whole truckloads of marks to buy bread. Families saving for a home, or other major purchases saw the value of their savings wiped out overnight – their future dreams beyond their reach in a period of hours. What had been a good salary one day would not even buy groceries the next.

Germany was, by 1923, simply unable to meet any of its reparations obligations. This would have major effects on the mountain of debt that the allies had built up internationally during the war. The United States, which had been in debt to the rest of the world to the tune of more than three billion dollars, loaned nearly twelve billion to European countries during the Great War. Most of this was owed to the U.S. by Great Britain, but Great Britain was owed huge sums by other countries as well. France owed three and a half billion dollars to Great Britain and the United States, and was in turn owed huge sums by Russia – up to a full quarter of all of its foreign loans. When the Bolsheviks took over, one of Lenin’s first financial moves was to repudiate all foreign debt. This devastated France, and left it with little to use in paying Britain and the U.S..

As your textbook points out, international debt of this scale could only be transferred as gold bullion, or by the sale of goods, which would provide foreign currency revenues which could be taxed, then used to repay loans. The scheme the Europeans planned to follow involved the latter method. With this in mind, European countries encouraged trade with the United States in order to be able to make the payments they owed.

This debt problem was combined with the fact that immediately after the war, the European countries who had participated relied on Japan and the United States to supply them with food and industrial goods and equipment as they rebuilt their infrastructures. This problem really went unseen, and so it was with some surprise, and great confusion, that the United States and Japanese agricultural sectors began experiencing serious declines in the mid-1920’s. These declines were exacerbated by the fact that the market had been so good. It seemed in the early 20’s that farmers could not grow enough of anything – demand was always greater than supply. This kept prices firm, and encouraged farmers to increase production by increasing their acreage. This they did with bank loans, secured with the property they already owned. Many also had to by farm equipment to make possible production on a larger scale. These tools they also bought on loan.

When the demand for American and Japanese agricultural products began to drop in the mid-1920’s, farmers and banks were caught by surprise. As prices plummeted, and markets eroded, farmers began simply abandoning crops they had grown. They were unable, in both countries, to make payments on their loans, and banks foreclosed. Foreclosure was useless, though, because there were precious few people in either place that had the money or the interest in buying land. This meant banks were unable to recoup their losses on the loans to farmers, and began to experience a cash shortage.

In the United States, at that time, there was no banking regulatory commission, no Federal Deposit Insurance Corporation, nor any other government means of controlling bank policies or interest rates. This meant that banks could take huge risks in making loans, and were not required to maintain any reserve cash to cover deposits. Once the loans were in default, the bank’s capital was often exhausted, and depositors could simply not get their money.

This banking crisis was already a serious problem as early as 1928, when 600 banks were failing each year.

Industry in Japan and the United States, however, was still in a boom cycle between 1925 and 1929. These two were the only advanced industrial nations to have taken no serious damage to their industrial infrastructure, and so were able to supply both the world, and expand to continue supplying their domestic needs.

The continued boom in industry fueled several years of speculation in stocks and bonds. Lack of regulation of the stock markets allowed prices to make drastic moves over a single day, and re-open the next day to begin their climb all over again. This dizzying upward movement tempted more and more average Americans to invest in the stock market – most with no clear knowledge of what they were doing. Its sustained upward growth fooled many into thinking they couldn’t lose. Everyone expected to get rich quick on the market.

In October of 1929, however, this investment boom came to a sudden halt as the economic realities began to catch up with the stock market fantasies. European imports were seen in the United States as competition for American firms who were under pressure and needed to sell more. They were under pressure because the agricultural sector – still the largest part of the U.S. economy in the 1920’s, was suffering severe setbacks, and farmers were not buying farm or consumer goods. The U.S. Congress took up the question of how to protect American industry from foreign competition in a contracting market, and decided to set up a system of tarriffs – taxes on goods entering the country – to discourage imports, and encourage import substitution by American firms.

Their attempt to save the economy backfired. Rather than create a captive set of American consumers who would support American companies by buying their goods (because there were no others available), the Smoot-Hawley Act (the trade protection bill) actually set up barriers to the international flow of money.

Without access to the American market, European countries could not earn American currency, and had to attempt to pay loans in their own deflating currencies. When they could not make their payments, American banks which had provided the money for the loans had no recourse. The money that was late, or in default, was simply lost to American banks and, just as with the agricultural crisis, banks could not cover their deposits and failed.

All of this came to a head on October 24, 1929, also known as Black Thursday, when the New York Stock Exchange lost nearly 2/3 of its value in a single day of trading. Stock speculators were ruined by the thousands. Their money, which might have been used for investments, just went up in smoke. Large sectors of the economy lost all investment support, and so all ability to grow business or invest in new equipment or, most importantly, in employees.

With industry mechanized, but still in its early stages of automation, most factories operated with a huge dependence on human labor. As companies went bankrupt, and factories closed, their laborers were left out in the cold – no job retraining, no prospects, no Social Security income, no Welfare, no Medicare or Medicaid. If you lost your job in this society, you lost everything. The problem was, of course, that thousands were losing their jobs. By 1929, the unemployment rate in the United States was 24.5%. One in four people was without a job, and without prospects for one.

As the United States crashed, its trading partners did, too. As American trading partners crashed, their business partners also felt the effects. Like the ripples of a stone thrown into a quiet pond, the depression spread throughout the world until nearly every country saw itself set back, sometimes below the living standards it had experienced a full century earlier.

As the world crashed economically, people worldwide began to wonder exactly why things weren’t working as expected. The scientific advances of the 19^th century, combined with European success at conquering and controlling large parts of the non-European world, increased numbers of democracies, successful treaties that prevented war and maintained the balance of power – all of these things had suggested that the story of humanity was the story of progress.

But the story of the First World War was a technological nightmare – nine to thirteen million deaths, an untold number of lost contributions to society, the loss of agricultural land, destruction of towns, factories, homes, memories and lives. The Treaty of Versailles was an exercise in vengeance and unrealistic. The Great Depression was the story of shortsighted and selfish isolationist behavior combined with lack of fiscal responsibility and unrealistic expectations by all involved. None of these things seemed to be progress in any but the most superficial ways. Humankind, especially Europe, but significantly, its colonies as well, began to question the values that had led up to the war. The search for solutions – ways to clean up the mess in human lives and set right the economic waste of the Great War – was first on the agenda of nearly every country even peripherally involved. Next was to make sure that the solutions created did not lead to the same problems again. Ironically it was, in fact, the modern solutions to these modern problems that would lead directly to the Second World War, and this time greater technology and better control of larger populations meant not 13 million, but 50 million lives would be lost – most needlessly – and the world economy would again be demolished in the name of nationalism progress.

World War II Lecture - continued here