This blog post examines why the Great Depression, which began in the U.S. in 1929, spread worldwide and whether it could have been prevented, exploring its causes and background.
What was the real cause of the Great Depression?
The Great Depression that swept across the world in the 1930s was an unprecedentedly severe and prolonged economic downturn in the history of capitalism. Its repercussions transcended borders, affecting the entire world, and its impact extended far beyond a simple economic crisis, leading to massive turmoil across society and politics. The epicenter of the Great Depression was none other than the United States, symbolically marked by the stock market crash at the New York Stock Exchange in late 1929. So what exactly went wrong?
The Shadow of Imbalance Cast Over Prosperity
On the surface, the United States of the 1920s enjoyed astonishing economic prosperity. Productivity improved rapidly, and a mass consumption society took root, seemingly presenting the quintessential model of vibrant capitalism. Yet, underlying this facade lay serious structural problems.
While mass consumption was widespread in American society at the time, income and wealth inequality were steadily worsening. This led to a gradual decline in the spending power of the majority of the population, creating a dangerous imbalance of overproduction and insufficient demand.
The core industry driving economic growth was the durable consumer goods sector. The automobile industry was a symbolic example; by 1928, one in six Americans owned a car. Considering the income distribution at the time, this meant car purchase demand had effectively reached its limit. Private sector housing construction also became a temporary growth engine, but it soon reached a saturated state requiring no further investment.
So what could the wealthy, already owning large homes and multiple cars, possibly consume next? Ultimately, they turned not to productive investments but to the ‘speculative market’—the stock market. Moreover, even ordinary farmers joined the speculative frenzy, taking out bank loans to dive into the stock market. But what awaited them was the nightmare of bankruptcy, too dreadful to imagine.
Why did the FRB’s monetary policy fail?
One key factor often cited for worsening the Great Depression was the monetary policy of the U.S. Federal Reserve Board (FRB). At the time, most directors of the 12 regional central banks under the FRB came from member banks. They shared a mindset similar to local financial institutions and were largely unskilled in macroeconomic policy responses or monetary policy operations.
How did such unprepared individuals respond to the gradually overheating stock market at the time?
While the FRB couldn’t directly control the stock market, it could indirectly influence banks’ lending policies by adjusting discount rates. Indeed, to cool the overheated stock market, the FRB raised the discount rate, making it harder for banks to lend funds for stock purchases. However, the speculators’ expectations of high profits from stock investments remained unshaken; they continued borrowing, taking on even greater risks.
Banks, too, lent against stocks owned by their customers. While this posed no problem as long as stock prices kept rising, once prices fell, the value of the collateral plummeted, inevitably causing the credit structure itself to collapse.
Ultimately, when the stock market crashed in 1929, the FRB missed a decisive opportunity to reverse the situation. Instead of expanding the money supply to secure market liquidity, the FRB chose a policy of reducing the money supply. This caused severe deflation, and the rise in real interest rates completely froze corporate investment sentiment. It was precisely at this point that a simple stock market crash expanded into a full-blown Great Depression.
The Global Spread of the Great Depression: Where Was the International Credit System?
So why did the shock of this Great Depression spread worldwide? To explain this, we need to understand the international financial system, particularly the state of the Gold Standard.
The international Gold Standard, suspended during World War I, was reestablished after the war but remained structurally highly unstable. The central player in the international credit system at the time was the United States, the largest creditor nation after the war.
The U.S. enjoyed massive surpluses in its international balance of payments through interest on capital exports and the repayment of principal and interest on war debts. Combined with its traditional protectionist trade policies, this also resulted in a trade surplus. Consequently, it became nearly impossible for debtor nations to repay their debts through trade, leading to an ever-increasing inflow of gold into the United States.
Had this inflow of gold led to increased money supply and inflation, the situation might have eased. However, the U.S. government was resolutely opposed to inflation, and the Federal Reserve opted for a ‘sterilization policy’—absorbing the inflowing gold rather than releasing it into the market.
In fact, for the international gold standard to function stably, a strong ‘lender of last resort’ was essential. Unlike the Bank of England, which had played this role in earlier times, the U.S. Federal Reserve was dedicated solely to domestic price stability, not international financial stability. Ultimately, the U.S. effectively ignored the rules of the international gold standard, and as a result, the Great Depression spread into a global catastrophe.
Was the Great Depression unavoidable?
While history has no “what ifs,” many economic historians assess that had the United States adopted more open and proactive monetary and fiscal policies in the 1920s, particularly during the critical period from 1929 to 1933, the Great Depression could certainly have been mitigated or shortened in both scale and duration.
This implication remains valid in today’s global economic system. History silently testifies to how crucial it is not to overlook macroeconomic warning signs and to design financial systems with international cooperation and flexible response capabilities.
Conclusion
The Great Depression of the 1930s went beyond a mere financial crisis, becoming an opportunity for fundamental reflection and redesign of the capitalist system as a whole. We, living in this era, must also revisit the lessons of the Great Depression in the face of recurring economic crises.
The Great Depression was not an accidental catastrophe. It was a ‘crisis foretold,’ brought about by unbalanced growth, ignorant monetary policy, and an irresponsible international financial system. And its history asks us: Are we prepared to avoid repeating the same mistakes?
