Causes of the Great Depression

Causes of the Great Depression

The Long Bull Market • Sometimes the stock market experiences a long period of rising stock prices, called a Bull Market • A prolonged bull market in the 1920s convinced many Americans to invest heavily in the stock market • By 1929, about 3 million Americans owned stock – roughly 10% of all households

Margin Purchases • Convinced that the market would continue to grow, many people started buying stock on margin • Make a small down payment for a stock • For example, buying $10,000 worth of stock for only $1,000 (10%) • As long as stock prices kept rising, buying on margin was safe • If bankers got nervous they could issue a margin call, demanding that the investor repay the loan at once • These margin calls made investors very sensitive to any fall in stock prices • If prices fell, they had to sell quickly or they might not be able repay their loans

Speculation • Before the late 1920s, prices investors paid for stock was generally an accurate reflection of the stock’s true value • People typically bought based upon a company’s long-term ability to be successful • The huge increase in investors changed this – people bought stock, which increased the stock’s value without any regard to the company’s ability to be successful • People bought stock for a short-term windfall, hoping that the stock’s value would climb rapidly and they could quickly sell off their shares to make a profit

The Great Crash • The bull market lasted only as long as investors continued putting new money into it • By the 2nd half of 1929, the market was running out of new customers • In September professional investors sensed a change and began to sell off their holdings, which caused prices to fall • Other investors sold shares to pay the interest on their loans, which caused prices to fall further

Black Tuesday • On Thursday, October 24, 1929, the stock market plummeted, sending people scrambling to get rid of their stocks while they still had value • The sell-off of the 24th was overshadowed by the huge crash that happened on October 29, 1929, called Black Tuesday • On that one day, stocks lost between $10 - $15 billion in value • By mid-November, prices had fallen further and the total losses for the year topped $30 billion

The Crash and the Great Depression • The crash was NOT the major cause of the Great Depression, but it did undermine the economy’s ability to withstand other weaknesses • The real damage to the economy happened in the nation’s banking industry

Banks in a Tailspin • The crash weakened banks in 2 ways: • Many banks had lent money to stock speculators • Many banks had invested depositors’ money in the stock market • For some banks, the losses they suffered in the crash were more than they could absorb and they were forced to close • At that time, the government did not insure bank deposits – if a bank collapsed, customers lost all of their money • The bank failures of 1929 and early 1930 caused a crisis of confidence in the banking system

The Collapse of the Banking Industry • People heard that banks were closing, taking all of the depositors’ money with them, which caused panic • People began to make runs on the nation’s banks, demanding all of their money up front • Banks make a profit by lending money to others – money that comes from its depositors • Banks hold only a fraction of their total deposits at any given time to cover everyday business • Those reserves are usually enough, but if too many people withdraw their money at once the bank will collapse • Between 1929 – 1930, more than 3,000 banks closed

Uneven Distribution of Wealth • Most economists agree that overproduction was also a contributing factor ofthe Depression • More efficient machinery allowed companies to produce more than people could purchase • Surplus causes prices to fall • In 1929, the top 5% of all American households earned 30% of the nation’s income • Most households had little expendable income

Credit Problems • While most households had little extra money to spend, they wanted to enjoy some of the new technologies available • People bought high cost items, like refrigerators, and cars, on the installment plan • Some buyers reached a point where paying off their debts forced them to reduce other purchases • This low consumption led manufacturers to cut production and lay off employees

Manufacturing Slowdown • The slowdown in consumption touched all industries • For example: radio sales slumped, so makers cut back on their orders for copper wire, wood cabinets, and glass radio tubes. Montana copper miners, Minnesota lumberjacks, and Ohio glassworkers then lost their jobs. Jobless workers had to cut back on purchases, further reducing sales.

Loss of Export Sales • Some jobs may have been saved if American manufacturers had sold more goods abroad • U.S. banks chose in the 1920s to lend money to stock speculators instead of foreign companies. Without these loans from U.S. banks, foreign companies purchased fewer products from American manufacturers

Hawley-Smoot Tariff Act • In June 1930, Congress passed the Hawley-Smoot Tariff Act, which raised the price foreign producers must pay to sell their items in the U.S. • The act was meant to protect American companies, but it did the opposite • Imports cost more because of the tariff, so Americans bought fewer imports. This caused foreign companies to put their own tariffs in place on American goods, which decreased the demand for American products around the world. • By 1932, U.S. exports fell to about 1/5 of what they had been in 1929

Mistakes by the Federal Reserve • When people began borrowing money to speculate in the stock market the Federal Reserve could have raised interest rates to curb the excessive borrowing • Instead, they kept the interest rates for loans very low • This was a key piece of the Great Depression in 2 ways: • By keeping rates low, it encouraged banks to make risky loans • Low interest rates led business leaders to believe the economy was still expanding

The Nail in the Coffin • As the Depression was beginning the grow, the Federal Reserve made a grave error • Instead of keeping interest rates low to encourage businesses to invest and grow, they raised interest rates, making it very difficult for businesses to recover and hire employees • The economy continued to spiral down, out of control

Causes of the Great Depression