Causes Of The Great Depression Of 1920 Economics Essay

Deflation – A general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression. Central banks attempt to stop severe deflation, along with severe inflation, in an attempt to keep the excessive drop in prices to a minimum. (Investopedia)

Recession – A significant decline in activity across the economy, lasting longer than a few months. It is visible in industrial production, employment, real income and wholesale-retail trade. The technical indicator of a recession is two consecutive quarters of negative economic growth as measured by a country’s gross domestic product (GDP) .(Investopedia)

The Great Depression of 1920-21 was a devastating time in American history and a changing point in American society. During World War I (1914-1918) federal spending grew three times more than tax collection, so when the US government cut back on spending to balance the Federal Budget of 1920 (from $ 18.5 billion to $ 6.4 billion) and the Federal Reserve raised the interest rates (up to 7% by June of 1920), a severe deflationary recession resulted and the economy all but slowed to a standstill. The cost of borrowing money was so steep, both to other banks and to companies that banks were foreclosing on debts at a very quick rate, putting people out of their homes, their lands and their businesses.

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After the US entered the war in 1917, there was a period of rapid economic growth in the country: the war economy invested heavily in the manufacturing sector which saw an explosion of productivity; the agricultural industry saw an increase in the demand of their produce to meet the needs of Europe, leading to an increase in farm product prices and income, thus driving the farmers to expand their lands and purchase new machinery to meet the surge in demand.

The end of the war put an end to this economic boom, especially in the agricultural sector and in the small manufacturing companies: in the period going from January 1920 to July 1921, farm prices virtually collapsed, human resources were reallocated from small, slower growing companies to rapidly expanding sectors such as the automobile industry, the radio industry and the large manufacturers of electrical appliances, and the factories which had been employed during the war time had to retool their production or shut down all together.

It is said that economic growth never occurs in all sectors at the same time and at the same rate: some sectors expand faster than others according to the introduction of new technologies, products and services and changing consumer tastes. The foreclosures on farmers and the return of the soldiers engaged in Europe increased the workforce dramatically – in 1920 alone the civilian workforce increased by 1.6 million people , but the businesses striving for increased productivity and efficiency were replacing workers with machineries, thus the economy was not prepared to re-absorb these people and many remained unemployed. Companies were investing more on machines than on wages, production costs fell quickly and prices started to drop thus starting a period of deflation.

Another major cause of the Depression was that as unemployment rose and the worker’s salaries did not increase, people could not afford the goods that were being manufactured, the factories made no money and the goods went unsold. The farmers were still paying off the machinery bought to increase the production during and right after World War I, so they had no extra money to buy the manufactured goods produced by the factories.

Small businesses could not compete with the large corporations, money distribution was disproportionate and a huge class division was created, with less that 6% of the population holding more than 33% of the country’s wealth.

Overall the economic situation was very grim: unemployment had jumped from 4% in 1919 to nearly 12% by the end of 1920, the GNP (Gross National Product) had declined 17% in the same period and the Consumer Price Index indicated a drop of 11.3% from 1920 to 1921. This condition prompted President Warren G. Harding to cut the government’s spending in half between 1920 and 1922, lower the income taxes from 77% to 25% and reduce the national debt by 1/3. Herbert Hoover, as a member of the Harding administration would have opted for a more involved government intervention, but President Harding’s “laissez-faire” handling of the situation ultimately proved to be correct: the recovery was swift and by the end of summer of 1921 the unemployment rate had dropped to 6.7%.

In 1921, Calvin Coolidge’s introduction of the ‘Instalment Plan’ stating that “people could purchase on credit and pay in monthly instalments”, gave a non realistic demand for products which further taxed the pockets of those who were struggling to make ends meet. It is calculated that more than half of all instalment debts at the time were for the purchase of cars.

It is widely believed that the 1920-1921 Depression “purged the rottenness out of the system” and provided a solid framework for sustainable growth that led the United States in what is known today as the ‘Roaring Twenties’, a period of social, artistic and cultural dynamism in which the US gained dominance in world finance. This period is also known for several inventions (radio, cinema, records) and discoveries, extraordinary industrial growth (led by the automobile industry), accelerated consumer demands and objectives and substantial changes in lifestyle and culture.

Technology played a very important role in delivering the economical and cultural good times that most Americans enjoyed from mid-1921 to October of 1929, when Wall Street crashed. The mass production of automobiles is considered to be the single most important factor of growth of the era: before the war cars were a luxury, but in the 1920’s mass production of automobiles became common, and by 1927 Ford had manufactured and sold more than 15 million Model T’s. This in turn led to the construction of new roads and highways, pouring fresh funds into the economy and distributing the wealth.

The effects of the automobile industry were exceptionally widespread, contributing to the building of service stations along the roads, used car dealerships and building of neighbourhoods outside of the big cities and the range of mass transit.

People were encouraged through advertising to buy consumer goods, mass production of these goods made them more accessible, wages were higher because of the economic prosperity and purchases could be paid in months or even years thanks to the Coolidge Instalment Plan. Assembly lines were built in factories and the prices of the manufactured goods dropped considerably as fewer workers were employed to perform the same operation: a car with an average cost of $850 in 1908 would cost only an average of $290 in 1925. The Ford factory in Detroit was fully automated by 1925, one machine would paint a line on the chassis that would have taken ten workers to perform before the assembly line was introduced.

Most Americans enjoyed a high standard of living albeit on over extended credit: houses were purchased and were filled with new electrical appliances such as refrigerators, washing machines, radios, phonographs and electrical irons. People had more time on their hands: listening to the radio became the national pastime and radio advertising helped to accelerate the economic growth of the decade.

Increased productivity meant corporate profits were re-invested into the factories and distributed as higher wages. Everyone went on a spending spree as credit, not savings, allowed consumers to boost corporate profits to unprecedented levels.