Rough Times Ahead, Part I: Revisiting the Great Depression
The recent economic events have piqued my interest in The Great Depression and Crash of 1929. Out of concern over the resiliency of the US economy, I began reading historical accounts of the depression era, and while browsing through books on the subject, came across Robert S. McElvanine’s aptly named “The Great Depression: America, 1929-1941.” The book has an eye-opening and intriguing section on the origins of the Great Depression.
Origins of the Great Depression
While most informational websites or articles attribute the Depression to income inequalities and the maldistribution of wealth, it should be noted that this particular problem was merely symptomatic of other structural economic flaws and was the one that ultimately broke the camel’s back.
First, the agricultural sector was in a depression well before the US economy as a whole slipped into one. Credit fueled expansion of the sector during WWI resulted in post-war overproduction which was exacerbated when the USSR increased production of and began exporting wheat. Furthermore, when the United States curtailed post-war loans to several European nations, increasing global supplies were met with decreasing demand. Commodity prices plummeted and cash-strapped farmers struggled to make ends meet. During the 1920’s, the agriculture sector, a sector that employed 1/4th of the United States workforce was a major drag on an otherwise prosperous economy (read Coolidge Prosperity).
Second, the 1920’s witnessed the birth of consumer payment plans. Unable to purchase the goods and services created through rapid industrialization, institutions stimulated demand by extending credit through payment plans. Just like today, this phenomenon resulted in unsustainable, debt driven overconsumption and again, overproduction. Companies continued producing goods that the average consumer, who was burdened by debt, couldn’t purchase. Had productivity gains of the decade been fairly distributed in the form of higher wages, the glut of mass produced goods could have been avoided. Not only was the United States in an agricultural depression, a majority of the non-agriculture employees were financially “tapped-out,” and demand for goods was disproportionally allocated to the wealthy.
Third, rampant speculation took hold. No one really knows what caused this bubble. The Federal Reserve’s decision to cut interest rates to 3.5% is the only hard data one can point to. Suffice to say, cheap money and expectations that the bull market of the Roaring Twenties would continue indefinitely, led to market speculation built on “margin” and “leverage.” Stock-backed loans, deemed a safe investment given prior stability of the financial markets, increased to more than $7 billion dollars prior to the crash. Interest rates on these loans, which rose to 12% ultimately increased the interest rates for businesses as well. Unable to justify borrowing at such high rates, businesses delayed investment spending. A downward spiral of deleveraging worsened by panic and fear ensued once the market started falling apart. Since market ownership was concentrated (held by the wealthy), they felt the most pain and subsequently constrained the very spending that the economy depended on.
Overproduction of industrial and agricultural goods and weakening demand started affecting businesses, who took prudent combative measures by cutting production and cuttings costs through layoffs. The unavoidable deflationary spiral resulted in decreased prices, squeezed profit margins, and a 29%+ unemployment rate. Coolidge Prosperity was dead.
The Road Ahead
The Crash of 1929 was not the Great Depression’s singular cause. Rather it was a number of intertwined, ostensibly disparate economic flaws that acted in concert. Having examined the causes of the Depression, can the examination be instructional today? Have the excesses of the past decade (cheap money, speculation in housing, expansion of Collateralized Debt Obligations, Credit Default Swaps and other exotic instruments, margin and leverage) set the United States up for another unavoidable deflationary spiral? Stay tuned for the next post.
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My name is Arpan and this is my blog! I'll be writing about things I find interesting, and hopefully some stuff that you might too. Some posts are intentionally controversial and are intended to provoke discussion. Don't be shy!
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