What Caused the Great Depression?

What Was The Great Depression?

Before we can explore the causes, we first need to define what we mean by the Great Depression.
The Great Depression was a global economic crisis that may have been triggered by political decisions including war reparations post-World War I, protectionism such as the imposition of congressional tariffs on European goods or by speculation that caused the Stock Market Collapse of 1929. Worldwide, there was increased unemployment, decreased government revenue and a drop in international trade. At the height of the Great Depression in 1933, more than a quarter of the U.S. labor force was unemployed. Some countries saw a change in leadership as a result of the economic turmoil.

When Was The Great Depression?

In the United States, the Great Depression is associated with Black Tuesday, the stock market crash of October 29, 1929, although the country entered a recession months before the crash. Herbert Hoover was the President of the United States. The Depression continued until the onset of World War II, with Franklin D. Roosevelt following Hoover as president.

Possible Cause: World War I

The United States entered World War I late, in 1917, and emerged as a major creditor and financier of post-War restoration. Germany was burdened with massive war reparations, a political decision on the part of the victors. Britain and France needed to rebuild. U.S. banks were more than willing to loan money. However, once U.S. banks began failing the banks not only stopped making loans, they wanted their money back. This put pressure on European economies, which had not fully recovered from WWI, contributing to the global economic downturn.

Possible Cause: The Federal Reserve

The Federal Reserve System, which Congress established in 1913, is the nation's central bank, authorized to issue the Federal Reserve notes that create our paper money supply. The "Fed" indirectly sets interest rates because it loans money, at a base rate, to commercial banks.
In 1928 and 1929, the Fed raised interest rates to try to curb Wall Street speculation, otherwise known as a "bubble." Economist Brad DeLong believes the Fed "overdid it" and brought on a recession. Moreover, the Fed then sat on its hands:

"The Federal Reserve did not use open market operations to keep the money supply from falling.... [a move] approved by the most eminent economists."

There was not yet a "too big to fail" mentality at the public policy level.

Possible Cause: Black Thursday (or Monday or Tuesday)

A five-year bull market peaked on September 3, 1929. On Thursday, October 24, a record 12.9 million shares were traded, reflecting panic selling. On Monday, October 28, 1929, panicked investors continued to try to sell stocks; the Dow saw a record loss of 13 percent. On Tuesday, October 29, 1929, 16.4 million shares were traded, shattering Thursday's record; the Dow lost another 12 percent.
Total losses for the four days: $30 billion, 10 times the federal budget and more than the $32 billion the U.S. had spent in World War I. The crash wiped out 40 percent of the paper value of common stock. Although this was a cataclysmic blow, most scholars do not believe that the stock market crash, alone, was sufficient to have caused the Great Depression.

Possible Cause: Protectionism

The 1913 Underwood-Simmons Tariff was an experiment with lowered tariffs. In 1921, Congress ended that experiment with the Emergency Tariff Act. In 1922, the Fordney-McCumber Tariff Act raised tariffs above 1913 levels. It also authorized the president to adjust tariffs by 50% to balance foreign and domestic production costs, a move to help America's farmers.
In 1928, Hoover ran on a platform of higher tariffs designed to protect farmers from European competition. Congress passed the Smoot-Hawley Tariff Act in 1930; Hoover signed the bill although economists protested. It is unlikely that tariffs alone caused the Great Depression, but they fostered global protectionism; world trade declined by 66% from 1929 to 1934.

Possible Cause: Bank Failures

In 1929, there were 25,568 banks in the United States; by 1933, there were only 14,771. Personal and corporate savings dropped from $15.3 billion in 1929 to $2.3 billion in 1933. Fewer banks, tighter credit, less money to pay employees, less money for employees to buy goods. This is the "too little consumption" theory sometimes used to explain the Great Depression but it, too, is discounted as being the sole cause.

Effect: Changes In Political Power

In the United States, the Republican Party was the dominant force from the Civil War to the Great Depression. In 1932, Americans elected Democrat Franklin D. Roosevelt ("New Deal"); the Democratic Party was the dominant party until the election of Ronald Reagan in 1980.
Adolf Hilter and the Nazi party (National Socialist German Workers' Party) came into power in Germany in 1930, becoming the second largest party in the country. In 1932, Hitler came in second in a race for president. In 1933, Hitler was named Chancellor of Germany.