GDND - Causes Of the Great Depression (Lesson)

Causes of the Great Depression

What is interest?

Here is a chart that demonstrates how interest can be applied to a debt or an investment over a period of ten years.

Overproduction

The Roaring Twenties was a decade of economic boom. Americans’ wages increased by 22% and the United States’ GNP (Gross National Product) increased from $69 billion to $93 billion between 1921-1924.

Photograph of Female Factory Workers By Gordon Parks, Library of Congress, Public Domain Industries increased output to keep up with demands for new technologies, inventions and innovations. Technical advances and more efficient automated processes like the assembly lines in factories led to increased, less expensive production of highly sought after consumer goods like refrigerators, electric irons, washing machines, electric razors and vacuum cleaners.

Electricity and industry teamed with advertising and a consumeristic attitude for new appliances. However, consumers eventually were not interested in new appliances and products. Furthermore, European markets were hitting an economic downturn and became less likely to purchase American goods. Industries continued to produce which only drove down demand and prices for their goods creating a surplus of products.

Under-Consumption

As markets in Europe declined, so too did markets in the United States. By the time of the stock market crash of 1929, Americans were spending less on luxuries. Combined with over production, under-consumption only created more of a surplus of consumer goods. These two issues damaged industries further which affected jobs and communities dependent on those industries.

Woman and child storing food. By Unknown - Franklin D Roosevelt Library Website, Public Domain

Overspending

The Roaring Twenties’ growth in wealth was best seen in the stock market. Stocks are individual portions of a publicly traded company. As the company does well, the prices of the shares of its stocks increase proportionately. In opposition, as a company performs poorly, then so to do its stocks. American investors began to speculate on stock growth, meaning they gambled with their wealth in a frenzy. This can be likened to trying to win the lottery. Investors were also buying stock “on the margin,” meaning they were purchasing a larger portion of stock than the payment they provided. Thus, they became in debt to that company. If the stock did well, then the debt was paid. However, if the stock failed, their debt was realized.

For example, an investor might want to buy $1000 of stock in a company. The investor might have $100 of the needed $1000 and borrow the other $900 from a bank to buy the stock. If the stock performed well, the investor might make $1200, pay the bank the $900 loan and then show a gain of $300---the initial $100 plus a profit of $200 on that investment. BUT if the stock didn’t perform well, the investor was not only out the $100 he had originally but was also in debt to the bank for the $900 loan.

At the time millions of Americans invested in the stock market, many of whom were unable to afford potential losses. Finally, the ‘experts’ of the day promoted the idea that the stock market would never decline, that it was in a perpetual state of expansion and that there were no risks associated with stock investments; and those erroneous assurances that the stock market would never decline provided investors with a false sense of security.

Consumers were also using credit to purchase items they could not afford outright. Using credit allows the consumer to purchase a product and then pay off their debt over time. Credit uses interest to secure the loan for the bank or organization providing the credit. When consumers lost their incomes, they were not only unable to pay off the debt but could not pay off the extra interest either. Consumers’ quest for luxury items like electric refrigerators and irons, cheap automobiles and other new goods led them to purchase these goods on credit as never before seen. In fact Americans began to view these “luxury items” as “essential” to the “good life.”

Income Gap

An income gap is the distance between the wealthiest and the poorest people in a society.

Photograph of Poor tenant farmer in the South by Farm Security Administration, Public Domain The Industrial Revolution had helped to create a middle class of Americans. However, as consumerism and credit became the cultural norm, the middle class and impoverished grew. Americans became united as their debts were realized during the Great Depression. Furthermore, as new technologies emerged, certain industries and occupations suffered. For instance, new farming technologies limited the number of workers needed in farming and new mining technologies limited the number of miners needed in the labor force. Without work, these individuals could not provide for their families nor could they be consumers of products. The income gap distribution can best be explained as “the rich get richer and the poor get poorer.”

Run on Banks

With the stock market crash, industries closing and rampant unemployment, individuals sought to remove their savings from banks. As individuals sought their money, banks could not distribute money they held as most of the money had been loaned out. Banks began to “call in” loans, meaning those who took out the loans would now be forced to pay them back immediately rather than over time. This “call in” on loans prompted many Americans with loans to declare bankruptcy, meaning they declared they could not pay back the loans or debts. What resulted was a lack of funds to pay back to those who had secured their money in banks. The “run on banks” as it was called prompted many banks to go out of business and damaged the economy significantly since the banks didn’t have enough cash on hand to give all depositors all of the money they held in bank accounts.

Crowd at New York's American Union Bank during a bank run early in the Great Depression. The Bank opened in 1917 and went out of business on June 30, 1931. Courtesy of SSA.gov, Public Domain

Consider this

Should you buy on margin? Why or why not?

How it works... you open an margin account with your broker. You purchase 1000 shares at $10 each. You profit if the stock price increases, you lose if the stock prices drop.

 

INTEREST CHART COURTESY OF TIMBERLINE FINANCIAL

BUYING ON MARGIN INFOGRAPHIC COURTESY OF KALLAHISTORY12.WEEBLY.COM