Thursday, August 15, 2013

What were the underlying causes of the Great Depression?

The underlying
causes of the Great Depression were a perfect storm of bad news. 

#1. 
Agricultural overproduction.  During the 1920s technological innovations enabled farms to
produce more and more crop for less time and labor.  However, this began to outpace the
consumption of these crops, and as a result the price of these products began to drop.  In the
past, farmers had compensated for lower unit prices with sheer volume, but by 1929 prices were
so low, that producing enough volume to make up for the price was impossible.  In addition, if
no one was buying the price didn't matter. 

#2.  Wealth concentration. 
Although the 1920s had been a time of great urban prosperity, this prosperity was not spread
evenly.  Although wages had been rising, they had not kept pace with inflation.  As a result,
the power of people to buy goods was not keeping pace with the volume of goods produced.  When
this happened either prices had to fall or wages had to rise.  Businesses did neither, as that
would reduce their proficts.  As a result, consumers began to resort to credit, but that just
created a bubble in the economy, as credit eventually has to be repaid, and the wages to pay it
back didn't materialize. 

#3. Securities fraud came to light in the late
1920s.  Due to the rising profits of businesses caused by inflation outpacing wages, everyone
wanted a piece of the action.  This attracted many unscrupulous characters who capitalized on
everyones desire to own stock in the most successful companies.  Many of these schemers also
offered options to buy stock on margin, where a loan was taken out to buy even more stock, and
then the profit from the rising stock value paid back that loan, or was used to buy even more
shares.  But in September, the fact that fewer people were buying goods caused a chain
reaction. 

#4. Chain reaction: Farmers stopped buying, this caused the credit
and margin purchases to default when expected gains were not realized.  With money no longer
available spending dropped.  Declining spending reduced business revenues.  Businesses cut jobs
to compensate for dwindling revenues, reducing incomes.  Reduced incomes led to even lower
spending, and a vicious cycle erupted.  By 1932, unemployment was a staggering 25% (or more by
some estimates), the stock markets were at only 10% of their August 1929 high, banks were
closing in droves under threat of "runs," and the Great Depression had
begun. 

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