The Great Depression has central place in twentieth century economic history. All other depressions and recessions are from an aggregate perspective little more than ripples on the tide of ongoing economic growth. The Great Depression cast the survival of the economic system, and the political order, into serious doubt. A serious recession in modern times would be when gross domestic product (GDP) falls by 3% or 4% over two years. Between 1929 and 1932 America’s GDP fell by 30%.
Winston Churchill was on a visit to New York in 1929 on one of the worst days for share prices. Churchill was surprised not to see more frenzy among the brokers until he was told that rules prevented them from running, shouting or gesticulating. Churchill did witness something, though, that has become part of the grim history of the era: a man jumping to his death from a nearby hotel window.
Three days — Black Thursday, Black Monday, and Black Tuesday — come to to describe this collapse of stock values. The initial crash occurred on Black Thursday (October 24, 1929), but it was the catastrophic downturn of Black Monday and Tuesday (October 28 and 29, 1929) that precipitated widespread panic and the onset of unprecedented and long-lasting consequences for the US. The unemployment rate rose above 25%, with little social protection for the victims. Workers were idle because firms would not hire them to work their machines; firms would not hire workers to work machines because they saw no market for goods; and there was no market for goods because workers had no incomes to spend. Furthermore, the drought that occurred in the Mississippi Valley in 1930 was of such proportions that many people in the region became unable to pay taxes or other debts and had to sell their farms for no profit to themselves.
The crash followed a speculative boom of the American economy that had taken hold in the late 1920s, which had led hundreds of thousands of Americans to invest heavily in the stock market (in the period of 1923-1929 corporate profits rose 62%, dividends rose 65% and the average output per worker increased 32% in manufacturing), a significant number even borrowing money to buy more stock. The Roaring Twenties, as this period came to be known, was a time of prosperity and excess, and despite warnings against speculation, many believed that the market could sustain high price levels. The rising stock prices encouraged more people to invest; people hoped the stock prices would rise further. Speculation thus fueled further rises and created an economic bubble (at the market peak in September 1929 about 40% of stock market values were pure speculation). Shortly before the crash, Irving Fisher proclaimed, “Stock prices have reached what looks like a permanently high plateau.”
The euphoria and financial gains of the great bull market were shattered on Black Thursday, when share prices on the NYSE collapsed. Panic selling started. More than 12 million shares were traded in a single day as people desperately tried to mitigate the situation. This mass sale is often considered a major contributing factor to the Great Depression. The market lost $14 billion in value on that day. Some 9,000 banks, accounting for nearly half of America’s banking capital, failed in less than a year later.
The first instinct of governments and central banks faced with this crisis was to do nothing. Businessmen, economists, and politicians (Secretary of the Treasury Mellon who said ‘Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate’) expected the recession of 1929-1930 to be self-limiting. They expected workers with idle hands and capitalists with idle machines to try to undersell their still at-work peers. Prices would fall. When prices fell enough, entrepreneurs would gamble that even with slack demand production would be profitable at the new, lower wages. Production would then resume. Except that this scenario never materialized. Stock prices fell on Black Thursday and they continued to fall, at an unprecedented rate for a full month, bringing the entire economy to its knees.
When politicians and businessmen finally decided to act, their actions plunged the country into a longer, self-sustainable crisis. They reacted by introducing protectionist policies such as the passage of the Smoot-Hawley Tariff Act (raising import tariffs – in average by 60% – on more than 20,000 items and causing protectionist policies in the rest of the world in retaliation) through the Congress (purportedly resulting from Republican policies in 1928), causing more harm than the crash itself.
In 1931, the Pecora Commission was established by the Senate to study the causes of the crash. The Congress passed the Glass-Steagall Act in 1933, which mandated a separation between commercial banks and investment banks. After the experience of the 1929 crash, stock markets around the world instituted measures to temporarily suspend trading in the event of rapid declines, claiming that they would prevent such panic sales.
There is no fully satisfactory explanation of why the Depression happened when it did. The causes of the Depression are still actively debated among economists due to lack of consensus in describing the causal relationship between various events and the role of government economic policy in inducing or preventing the Depression. Milton Friedman and Anna Schwartz argued that the Depression was the consequence of an incredible sequence of blunders in monetary policy. Another popular theory is that the Depression was caused when investors became fearful of their stocks as markets expanded some focus to Europe, which still had nations that were economically damaged from WWI (war-induced inflation, brief recession in 1920 and 1921, chronic overproduction of food and resulting low prices, nationalistic selfishness).