Causes
of the Great Depression
I. The International
Economic Situation
The U.S. emerges from World War I as the
“Engine of Prosperity” – it is the source of capital needed to sustain the
European economies.
Circular flow of capital creates an unstable
international economy:
▪
Germany pays reparations to France and Great Britain
▪
France and Great Britain pay war debts to the U.S.
▪
U.S. loans money to Germany to pay reparations
So long as the U.S. continues to lend money
abroad, the system survives.
If an interruption occurs at any point in the
cycle, the entire system collapses.
Some observers realized the instability of
the system was dangerous and suggest an alternative:
▪ U.S. forgives French and British war
debts
▪ France and Britain drastically reduce
German reparation payments
▪ Europe focuses on reconstruction,
using loans from the U.S. for tangible improvements
But political reality makes this impossible.
Most Americans remained convinced that the
Europeans should pay back their debts in full. US Politicians are reluctant to
go against public opinion.
1922-1923
à Faced with mounting debt, Germany experiences
hyperinflation
TWO
Causes
1.
The
government is printing too much money.
▪ The more
marks the government prints, the less they are worth.
▪ The less money is worth, the less
goods it can buy. (This is another way of saying that prices go up.)
2. People expect
inflation to get worse (they expect their money to decrease in worth)
▪ Since they expect the value of the money they’re holding to decrease,
they try to spend it at fast as they can before its value goes down further
▪ When money
floods into the economy, prices of goods increase (More money chases the same
amount of goods, driving up the price of goods – this is inflation).
To combat destabilizing inflation, the German
bank declares it won’t issue more money.
People decide their money will now retain its
value, so they’re more willing to hold onto it.
In 1924, the Dawes Plan defers the
reparations obligation: short term payments decrease; payments stretched out
over a longer period. This makes it
easier for Germany to pay.
This temporarily stabilizes the economic
situation, but by 1928 U.S. investors no longer put their money into loans for
Germany. They get a higher return by investing it in the stock market.
1929
à U.S. Stock Market Crashes. This has a global effect:
▪ U.S. Capital
for foreign loans dries up, destabilizing the circular flow of money.
▪ Unable to
count on U.S. loans, Germany faces difficulty making its reparation payments.
▪ Unable to
count on German reparation payments, France and Britain threaten to default on
their debt payments to the U.S.
▪ President
Hoover finally suggests a one-year moratorium on reparations and debt payments
(1931); but this ends up being too little too late.
Many worry what will happen
when the year is up.
1931 à Largest commercial bank in Austria is on the
brink of bankruptcy. The Austrian government freezes the assets in the
bank. The money is still there, but
depositors can’t gain access to it.
A panic results. Depositors fear other banks will also freeze
assets, so they rush to withdraw all of their money from other banks in Central
Europe (primarily German banks). This
further undermines the German economy and contributes to growing political
instability, which the National Socialists [Nazis] exploit.
▪ Political instability in Europe
follows the economic instability.
Frightened investors withdraw gold from
Central European banks, sending much of it to the U.S. There are now fewer dollars AND less gold in
Europe.
II. Unwise Tariff
Policies
▪ After the stock market crash, people fear a business slump.
Consumers won’t buy as much if they fear losing their jobs.
▪ This
means consumers buy fewer imported products from Europe and as a result, the Europeans
have fewer dollars to pay off their debts to the U.S.
▪ As the
economy slips in the U.S., many demand a higher tariff to protect American businesses
from cheaper foreign imports.
Congress
passes the Smoot-Hawley tariff which significantly raises taxes on nearly
all imported goods. This produces numerous harmful unintended consequences:
▪ Prices go up
in the U.S. People can’t afford to buy
higher priced goods made in the U.S., so the tariff fails to protect domestic
businesses. Sales continue to slump.
▪ Europeans
retaliate by slapping tariffs on U.S. products.
Retaliatory tariffs hurt U.S. more than Smoot-Hawley helps U.S.
businesses
à U.S. customers may
not buy Swiss watches, but the Swiss won’t buy U.S. automobiles. A net loss for the U.S.
▪ Europeans
also retaliate by raising the prices on raw materials that the U.S. must import
in order to make manufactured goods à rubber, tungsten
(both needed in making cars).
As a result, U.S. products cost more and U.S.
customers can’t afford to buy them. Demand for products slackens. Production
slows. Workers are laid off. Fewer people have money to buy U.S. goods…and the
cycle spirals downward.
▪ Because high tariffs keep the Europeans from selling their
goods in the U.S., they lose access to dollars.
As a result, they have even more difficulty
in paying their debts to U.S. lenders.
Also, as a result of
being shut out of the U.S. market, their factories produce less, forcing
businesses to fire workers (who in turn can’t buy as much), and the European
economies spiral downward as well.
III. U.S. Tax
Policies
▪ During the 1920s, taxes decrease
substantially, especially on the wealthy.
▪ The theory is that, with more money in their pockets, the
wealthy will invest it in expanding American businesses, allowing companies to
hire more workers. Prosperity will “trickle down.”
▪ To an extent, this works. But there are limits
to how much can be produced and consumed when the vast majority of Americans do
not make enough money to buy all that is produced in American factories. It is
also hard to sell goods abroad since during the 1920s, the Europeans (our
primary market for exports) don’t have the money to pay for our goods.
▪ Unwilling to
expand production when demand is limited, many American businessmen put their
money into speculating on Wall Street rather than into tangible investments
like building factories. This results in
the speculative frenzy that leads to the stock market crash of 1929.
▪ Prosperity during the 1920s is
real, but also is fragile.
▪ Wages and
standard of living rise; access to credit is easier and allows the middle class
to buy products “over time” on the installment plan.
▪ By the end of the decade major sectors of the economy – radios,
automobiles, and housing in particular – stop expanding. Demand slackens.
Since so many other businesses depend on the
housing sector, economic instability appears to be on the horizon.
▪ At the first sign of economic turmoil (the stock market
crash of 1929), consumers fear for the future and stop buying. This sets off a
downward spiral in the economy à fewer people buying,
less needed to be produced, fewer workers needed, fear of losing one’s job
keeps even those who still have jobs from buying, still less is needed to be
produced, further lay offs…and the cycle continues.
IV. Lack of Economic
Knowledge
Every
man for himself – completely ignore the interrelatedness
of the emerging problem
n
Retaliatory
tariffs
n
US
still won’t forgive Allied war debt; Europeans—except Finland—default
n
1934
Johnson Act –prohibits American citizens from purchasing the securities of
governments in default on their war debts;
n
all that was accomplished by this measure was
the closure of American financial markets to Great Britain and France as the
undertook program of industrial expansion and rearmament to meet the Nazi
menace.
EACH
NATON ACTS IN WHAT IT THINKS IS ITS NATIONAL INTEREST
EACH
STEP PRODUCES UNINTENDED NEGATIVE EFFECTS ON OTHER NATIONS THAT RETALIATE
LOCKED
IN A DEADLY EMBRACE, COMPETING NATIONS MAKE CONDITIONS WORSE FOR EVERYONE
POLITICAL
INSTABILITY RESULTS
ECONOMIC
NATIONALSM QUICKLY MORPHS INTO IMPERIALISM BUT ALSO SOURS RELATIONS BETWEEN
COUNTRIES THAT SHOULD BY ALL RIGHTS HAVE STOOD AGAINST FASCISM MORE
AGGRESSIVELY AND IN A MORE UNINIFED WAY.
▪ Few political leaders understood the wide ranging
ramifications of the economic policies they pursued. For example, the
Smoot-Hawley tariff and the freezing of assets in Austria.
▪ National
governments looked out only for their own interests, disregarding (or failing
to recognize) the fact that their policies had a global impact and were
generating unintended consequences.