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Friday, July 29, 2011

Research Paper on The Great Depression - Causes of the Great Depression

It was in the decade of the 1930s that the United States suffered the longest, deepest and most pervasive depression in the American History.  It is in this period where the Great Depression which started in the United States spread to the other industrial countries causing a rapid decline in the production and sale of goods, sudden rise in unemployment, closure of banks and unprecedented increase in unemployment rates. (John A. Garraty, 1973) Its impact reached every nation and every social class. (John A. Garraty, 1973)

The Stock Market Crash in October 1929 was considered as the primary reason for the Great Depression.  While it is true that in October 1929 the stock market crashed and wiped out 40% of the paper values of the common stock, the collapse of the stock market and the Great Depression were just the results of what already appeared as serious flaws in the United States economy which started during the 1920s. 

Underlying Causes of the Great Depression
A. Indebtedness of Farmers
During the 1920s the United States focused more on its domestic affairs rather than the international issues.  The policy was to rebuild and get rich quickly.  New inventions and ideas were encouraged.  New fads and sounds were accepted by the mainstream American society.  Economic policies likewise centered on mass production of goods.  There was hope for a bright future among the American people. 

For a while it seemed that the United States was enjoying prosperity.  While this may seem the case, an analysis of the entire economic system and those that depended on it showed that the economy of the United States years before the Great Depression already rested on unstable grounds. 

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The huge financial indebtedness of farmers and the agricultural sector were one of the factors that contributed to the Great Depression.  It is important to stress that while the United States was at this time already an industrial country, nearly 50% of the entire population still lived in rural areas and were dependent on agriculture. (Dietmar Rothermund, 1996)  During the 1920s, the American farmers were already heavily indebted as they continued to borrow money from banks for the purchase of their own land.  Borrowings by farmers were secured by the land they purchased.  Aside from banks, farmers were also indebted to investors called the junior mortgagees. 

According to the United States Department of Commerce, the period between 1918 and 1921 was the time when indebtedness of the farmers soared and reached $14 billion. (Giovanni Federico, 2005) The indebtedness would not have been a serious problem for the farmers had they been able to sell their crops.  In 1920s however, demand for their products dropped creating an unnecessary supply of crops which resulted in the fall of the prices of their goods. (Giovanni Federico, 2005)  Consequently, majority of the farmers who were indebted to banks could not repay their loans.  As the farmers defaulted from their amortizations, banks were forced to foreclose properties used as collateral. 

B. Unsound Business Practices of Banks
The second cause of the Great Depression was the collapse of the banking system.  The banks were partly to be blamed for the Great Depression because of the unsound practices performed by banks during the 1920s.  One of these practices is the system known as the correspondent banking. (Gary Richardson, 2007) This is a banking practice by which a bank sought the services of other banks known as correspondent banks.  For instance, when a bank receives out-of-town checks the said bank needs only to deposit the checks to a correspondent bank.  This practice allowed banks to collect the value of the checks in advance instead of mailing the checks first to the drawee bank.  Correspondent banks also performed different functions such as providing supplies of coins and currency, conducting of wire transfers, facilitating investments in stocks and bonds and offering a line of credit.  (Gary Richardson, 2007) Because of these services banks relied on the services of correspondent banks. 

While the formation of complex web of interbank relationships facilitated banking transactions it was exposed to a weakness -- the possibility of a chain reaction.  When a correspondent bank closes, the banks which depended on it are also placed in jeopardy because of the deposits of other banks in the correspondent bank which are often substantial. (Gary Richardson, 2007)  Because the majority of banks were dependent on correspondent banks, the closure of a correspondent bank often leads to the suspension of operation of other banks.

The Banking System was also volatile as a result of the amounts loaned to European nations.  Between 1914 and 1919, the bankers in the United States agreed to lend substantial amount of money to Great Britain, France and other European countries. (Dietmar Rothermund, 1996) These countries however also suffered economically making the repayment of their loans very difficult.  Thus, by the end of the war private debts owed by European nations have reached nearly $3 billion while public debt owed by foreign governments to the US government reached $10.3 billion. (“Great Depression, Causes of”, 1999)

C. Culture of Commercialism
The people’s habit of buying more than what they actually needed also contributed to the Great Depression.  During the eve of the Great Depression commercialism pervaded as producers of goods encouraged the consumers to buy and consume more.  They devised many marketing strategies to encourage the people to buy more and so that people who have no capacity to pay for these goods could still make purchases through the use of credit cards.  The problem however was that the income of the majority of the Americans did not increase.  At this time in the United States history the income distribution was uneven. (Dietmar Rothermund, 1996) Capital was also concentrated in the hands of a few businessmen who thrived during this period at the expense of the employees who never received their just share of production. (Dietmar Rothermund, 1996)

The Great Depression
While there were differences in opinions on the cause of the Great Depression there was unanimity in opinion on its impact on the lives of the American people.  It is true that the United States had experienced many depressions and hardships in the past but the hardships suffered during the Great Depression were incomparable because of the extent of the problem it caused and the number of years it took for the United States to recover. (Robert F. Himmelberg, 2001)  Indeed, the economic decline which started from 1929 until the 1930s was without any parallel in American history. (Robert F. Himmelberg, 2001) 

During the eve of the Great Depression, the upper-class who reaped the benefits from the American economy decided to invest in the stock market.  Businessmen started to invest heavily in the stock market between 1927 and 1929.  Because the demand was high, the price of stocks started to increase beyond their worth on paper.  Because stock prices continued to rise more people invested in the stock market on the belief that the prices will continue to rise.  Even the working class was drawn into the stock market.  Because they did not have enough money to purchase these stocks they were forced to borrow large sums of money from lending institutions thinking that they can sell these stocks later at a profit.

Those who were the first to invest profited from their investment as the stock prices multiplied by nearly five times during the year 1927 until 1928.  In October of 1929, investors started selling their stocks.  Other businesses followed starting a collapse as the stock market lost $10 billion to $15 billion.  In November 1929, losses in the stock market reached $30 billion.

The collapse of the stock market was just the beginning of the worse things to come for the United States economy.  With the loss of billions of dollars, consumers lost their purchasing power.  Factories started to close down.  As factories closed, employees were terminated.  In some manufacturing plants, the workforce was reduced by almost 50% just to be able to be able to survive their losses.  As a result, unemployment soared from 3.2% to 24.9% within the next few years.  By 1932, almost 15 million Americans found themselves unemployed.  Others who were returned were forced to accept wage cuts or even part-time work. 

With the massive loss of job, more people could not afford to pay their amortizations.  The banking industry soon felt the impact of the Great Depression.  With the unemployment situation, repayment of debts became very difficult and banks became short on cash.  It must be stressed herein that many banks even lost their money because they also invested heavily in the stock market prior to its collapse. Soon, news spread that banks were running out of cash.  The public immediately withdrew their funds from their own banks leading to the collapse of some banks.  According to Gary Richardson (2007), the first bank which collapsed was the Bank of Tennessee, a subsidiary of Caldwell and Company, when it ceased operations in 1930. The suspension of operation triggered a chain reaction affecting the other companies under Caldwell and Company as well as the other banks.  Soon, depositors started withdrawing their money leading to collapse of the entire banking system. 

When the Great Depression hit the United States, its impact seriously affected the farmers and those dependent on the agriculture.  During the 1930s merchants and traders refused to purchase their crops unless they lower the price of their goods to the absolute minimum.  To make matters worse for the farmers, natural calamities struck further affecting their source of livelihood.

President Herbert Hoover initially took the situation lightly.  He thought that the economy was stable and sound and the situation will normalize after investor confidence returns.  He wrongfully identified the problem as an effect of the loss of confidence among investors in the United States economy. (R.G. Tugwell, 1953) He thought that public confidence can be restored if “"there could be prompt assurance that there will be no tampering or inflation of the currency; that the budget will be unquestionably balanced even if further taxation is necessary; that the government credit will be maintained by refusal to exhaust it in issue of securities." (R.G. Tugwell, 1953)

As a policy, Hoover tried to balance federal budget by cutting government spending and raising taxes.  This was however a mistake as it discouraged more people to spend their precious dollars at a time when injecting money into the economy was  necessary.  When the situation did not get any better, the government made a belated effort to provide emergency loans to banks and to help the states offer relief. Many considered these efforts as a little too late.  Moreover, there was a common perception that his long-term solutions were not at all suited to the short-term needs of the farmers, debtors, creditors, employees and the public in general. (Martin L. Fausold, 1977)

Despite the efforts made by the government, the people perceived their actions as weak.  The people eventually criticized the government for failing to provide aid to the unemployed.   Soon, the people who lost their jobs lived on the streets and created shacks from old crates and newspapers and formed shanties which they called as Hoovervilles.  Tension between the people and the government culminated in 1932 when more than 20,000 World War I veterans marched on the streets of Washington to ask the government for early payment of their bonuses which was not yet due until 1945.  When the veterans did not leave Washington, the government ordered the federal troops to send the veterans away.  It was only in 1936 that Congress passed legislation providing for cash payments of the bonuses of the veterans. (Lester G. Telser, 2004)

The failure of President Hoover to implement immediate reforms and to adequately respond to the problems brought about by the Great Depression catapulted Franklin D. Roosevelt to fame as news of his bold and innovative efforts to combat the Great Depression in New York spread.  He subsequently won the nomination as the candidate of the Democratic Party in the election.  In 1932, he became the President of the United States by seven million votes. 

Before Roosevelt assumed office, the economic situation in the United States was at its worse.  Foreclosures became more frequent.  Inflation rates shot up. (Cristina D. Romer, 1999) Unemployment rate soared.  Banks declared bank holidays.  Upon assumption of his office, Franklin D. Roosevelt immediately started to work and devised a plan to fight the Great Depression.  One of his first acts as president was to call a special session instead of waiting for the regular session to start in December.  He wanted the Congress to pass laws that will deal with the banking crisis, worsening economy and unemployment problems.  Because of his leadership, Roosevelt managed to convince Congress to pass legislations that will respond to the Great Depression. 

The New Deal
The New Deal Legislation refers to a package of economic programs Franklin D. Roosevelt initiated between 1933 and 1938.  The phrase originated in 1932 when Franklin D. Roosevelt made an acceptance speech at the Democratic convention in Chicago in which he promised that he will provide “a new deal for the American people”. (Rupert Cornwell, 2008)  It focused on relief, recovery and reform to help lessen the impact of the Great Depression.  The goal of the New Deal legislation was to give relief to the unemployed, to reform and improve business and financial practices and to promote recovery of the economy during the Great Depression. 

One of the programs under the New Deal was the Relief Legislation. One of the first laws passed was the Emergency Banking Act which sought to restore public confidence in the banking system.  This law required the examination of banks.  Those which are insolvent were closed down while those which are still liquid were reopened.  Slowly, this law helped regain public confidence in the banking system and the people started to put their money back into banks.  After the banking institutions has been saved by the legislations passed by Franklin D. Roosevelt and the Congress they focused their attention to the millions of Americans who were unemployed.  The thrust of the relief legislation is to provide relief to the people but at the same time required them to work.  In this relationship, Franklin D. Roosevelt attempted, and succeeded, to hit two birds with one stone by helping the unemployed and their families through the government assistance given while at the same time benefitting from their physical labor Among these projects were the construction of roads, streets, libraries and schools and other public buildings and forestry and flood prevention work.  Other projects involved the renovation and improvement of public buildings.   

Another program under the New Deal is the Recovery Legislation.  While the Relief Legislation focused on giving aid to the public, the Recovery Legislation focused on long-term and sustainable solutions to the economic problem brought about by the Great Depression.  One of the laws passed is the National Recovery Administration (NRA) which sought to help businesses by eliminating unfair competition.  Thus, while unfair competitions were prohibited and merger and combinations of companies were disallowed, the NRA temporarily suspended these prohibitions so as to encourage companies to engage in actions necessary for the continuation of their businesses.  The only requirement is that in exchange for this privilege businesses were required to provide their employees their minimum wages and were prohibited from interfering with their right to organize themselves and to bargain for better terms and conditions of employment.

The Reform Legislation is another program under the New Deal.  Believing that the government should take the lead role in making social and economic change, Franklin D. Roosevelt initiated sweeping reforms in social legislations.  One of these laws is the passage of the Social Security Act of 1935.  The Social Security Act of 1935 sought to address the problems of unemployment, old age and physical disability by creating a federal pension system funded by taxes on employers and employees. (Jerry W. Markham, 2004) Under this joint federal-state program, persons who were once employed but subsequently lost their employment may subject to certain requirements claim from the funds of this program.  Other legislations were the National Labor Relations Act which sought to ensure balance in the relationship between the employer and the employees by guaranteeing the right of the workers to form, assist, and join unions and to bargain collectively with their employers for the purpose of securing better terms and conditions of employment. (Robert Shogan, 2006) 

The Great Depression and the Global Financial Crisis
Dr. Krassimir Petrov citing Wall Street has declared that there is a consensus among businesses that the global financial crisis we have now is worse than the crisis the United States experienced since the World War II.  To a certain extent, there are some parallelisms with the present global financial crisis and the Great Depression in the 1930s.  First, the problems in the stock market which happened in the 1990s and the real estate during the 2000s is oddly similar with the stock market crash and the devaluation of real properties during the 1930s.  Second, is the prosecution of corporate directors and officers of companies such as Enron and Worldcom who were responsible for manipulating the financial statements of their companies with the assistance of accounting firms.  The same is similar with the conditions in the 1920s which led to the passage of laws and the creation of the Securities and Exchange Commission by President Roosevelt.  Third, is the policy of secrecy and non-transparency widely common among corporations during the 1920s and 1930s which gave them opportunities to hide their real financial conditions.  The same continues until today with the arrest of Kenneth Lay and Jeffrey Skilling of Enron and the recent arrest of Bernard Madoff, the person responsible for masterminding a sham investment scheme by virtue of which investors were encouraged to make investment in his business with a promise that the investors will receive huge return on their investment within a particular period without knowing that their investment will only be used to pay the profits of an earlier investor.

In one sense, the problems the nation is encountering today are similar with what America experienced during the 1930s.  Today, millions of American people are losing their job.  They have lost their home to bank foreclosures.  Their savings are dwindling.  The economy is faltering.  Indeed, recession has come to America.  While today’s problems are great, its magnitude and extent can never be compared to the Great Depression.  Today, there is social security that provides benefits to disabled workers and the retired employees.  The unemployment insurance is also in place today which provides immediate financial assistance to individuals who have been laid off and terminated from work.  There is also deposit insurance which protects the funds of depositors kept in banks.  In addition, minimum wage laws and other anti-discrimination laws are also firmly in place to protect the rights of workers.  Thus, the situation of today is different from the situation during the 1930s.  The United States is in a better position to fight the global financial crisis. 

The Obama administration’s first attempt to stimulate the economy is similar with the policy of Roosevelt.  Unlike the past administration which focused on dole-outs, Obama focused on long-term solutions to the problem with the injection of $789 billion economic stimulus package.  The economic stimulus package includes seven components: 1) cutting of taxes by $400 for individuals and $800 for families; 2) Payment of $250 to recipients of Social Security, veterans pension and SSI benefits; 3) greater access to child tax credit for working poor and expand earned-income tax credit to families with three children; 4) college tuition tax credit; 5) tax credit for first-time homebuyers in 2009; 6) deduction of sales tax on new car purchases; and 7) extension of unemployment benefits and suspension of taxes on those benefits through 2009.

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