The Process Leading to the 1929 Depression and Its Causes

There have been many different views on what the factors that caused the 1929 Depression were. These views were discussed especially by representatives of the Keynesian Movement and the Monetarist Movement in the period after 1929. Before going into the details of these theoretically based discussions, it is necessary to reveal the conditions that led to October 29, known as Black Tuesday, 1929.

Source: https://timesmachine.nytimes.com/timesmachine/1929/10/30/96008282.html?pageNumber=2

The strengthening of the American economy after World War I increased the interest of companies and society in the stock market. This interest caused both companies to create financing opportunities intensively through the stock market and households to invest intensively in the stock market. Stock investors used credit to purchase stocks. Almost 80-90% of the value of the purchased stocks was used for credit. In addition to households using credit to purchase stocks, companies also increased their use of credit significantly for their growth plans.

There was a bubble created by the expanding credit volume in the US economy. In other words, stock prices were inflating due to stocks purchased with high leverage, but these prices went far beyond reflecting the profits companies made through their activities. The data of the financial system revealed by the stock market and the real data revealed by the activities of companies were disconnected from each other.

The 1920s were years when important innovations were implemented, especially in the automotive sector. Production was increasing due to the economies of scale created by the new techniques used in production, but there was no demand to meet this increase in production.

The US industrial production index fell from 127 in June 1929 to 122, 117, 106, and 99 in September, October, November, and December, respectively. Automotive production, which was 660,000 in March 1929, fell to 440,000, 319,000, and 92,500 units in August, October, and December, respectively.

On October 24, 1929, companies in the stock market announced their financial data, and because the data was disappointing, that day went down in history as Black Thursday. In fact, on October 29, 1929, Black Tuesday occurred. Stocks lost $40 billion of their total value in one day. By the beginning of 1930, the American stock market had lost 90% of its value.

The fact that the real economy in the USA was not functioning properly before October 29, 1929 was not only evident in the automotive sector and the sectors supplying the automotive sector. The agricultural sector was also struggling to cope with decreasing profits. Developments in the agricultural sector were similar to those in the automotive sector. With the increasing inclusion of technology in the agricultural sector, efficiency in production increased and the amount of production increased significantly. However, there was no demand to absorb this production. Therefore, American farmers were losing income and profit due to falling agricultural prices.

The weakening of the agricultural economy also had negative effects on the American banking system. There were more than 30,000 banks in the country, and a significant portion of them served rural areas. The negative effects on the agricultural economy resulted in the collapse of these banks. Between 1923 and 1930, about 5,000 banks were left out of the system.

A stock market crash results in the initial decrease in wealth in an economy and a decrease or loss of confidence in the economy. As a result, there is a significant decrease in the number of firms coming to the stock market for funding. These were the effects of the 1929 crisis. The collapse in the US stock market turned into a great depression.

In the second article of this series, I touched upon the common characteristics of the causes of crises and briefly summarized the crises seen in the years following the scientific birth of economics. The qualitative reasons for 1929 were no different from the others.

The unemployment rate in the US rose from 3.2% to 24.9% from 1929 to 1933. Over 9,000 banks in the US closed. The crisis that started in the US spread to a global dimension and then currency wars broke out. Currency wars turned into trade wars. In the US, many countries started to implement tariffs against the tariffs known as Smooth-Hawley and international trade collapsed. There were countries that could not service their foreign debts, the most important of which was Germany. The situation Germany found itself in had reached a level that brought Hitler to power by election in 1933.

The US Central Bank, the Fed, was established in 1913. It was the product of another crisis in 1907. It had a lot of work to do in 1929. Instead of taking measures to increase the money supply as a monetary solution to the crisis, it took measures to reduce the money supply. The shrinking money supply between 1929 and 1933 made the liquidity conditions of the US negative and turned the crisis into a depression.

The world after World War I was very different from the pre-war world. The United States had spent the 1920s continuously increasing its level of prosperity. Electricity had spread throughout the country. The number of registered vehicles had increased from 8 million to 23 million. New housing construction had exploded. The public believed that this process could continue uninterrupted. There was another person who held this view and was greatly discredited for his view and his failure to see 1929 coming: Irving Fisher.

Fisher, as described in a previous article in the series, was the person who made the quantity theory known by his name. However, he failed to see the above-mentioned break between the real and financial sectors and thought that the prices formed in the stock market before 1929 were permanently settled in the upper plateau. Interestingly, after the depression began, he was one of the first names to try to explain the causes of 1929.

By 1925, the US production level was 48% higher than in 1913. In addition, Central Europe had not recovered from the effects of World War I. In Germany, the general price level had doubled in 1919 and tripled in 1920. In 1922, the price increase was 1,600%. The German Mark collapsed in 1923. Prices increased by 486 million% in 1923. While $1 = 4.2 Marks in 1913, it became $1 = 4.2 billion Marks in 1923. Unemployment rose to 10% and remained at this level almost throughout the 1920s.

In the period following the 1929 crisis, unemployment was 26% in Germany, 27% in the Netherlands, 24% in Sweden, 33% in Norway, and 21% in England in 1933. The effects of the depression continued throughout the capitalist world throughout the 1930s. Under Nazi rule, Germany managed to reduce unemployment to 2% in 1938.

In the period following World War I, economic activity was stimulated by movements in money and financial markets. The US had taken over world leadership from England and the role of financial markets in its own economic order had increased significantly. There was an important reason behind the spread of the stock market crash in the US to other countries: intergovernmental borrowing.

This was an application unknown to the world before World War I. While European countries were borrowing from each other, the largest of these borrowings were from the USA. Therefore, inter-country borrowings played a major factor in the spread of the crisis that emerged in the USA. 1929 showed that the financial system was an inseparable part of international trade, but also had a fragile structure.

1929 created Keynes. Keynes was expressing some policies that were significantly different from the Classical School and had never been proposed before. Because his suggestions were presented as a solution to the depression that 1929 created. Keynes argued that in order to revive a depressed economy, a public deficit should be created by increasing public spending.

In his work "The General Theory of Employment, Interest, and Money" published in 1936, he explained the mechanisms that brought an economy to a standstill. The work brought up a very important emphasis on the market. Markets could not always work effectively and efficiently. With the introduction of mechanisms that eliminated efficiency and productivity, it might be necessary to mobilize public spending for an economy experiencing depression.

There were also schools of economics that examined the causes of the 1929 Economic Depression after Keynes and presented the results of their analysis. The most intensely discussed and current results of these analyses were the school represented by Keynes and the school represented by Milton Friedman.

Keynes saw the cause of the depression as a deficiency in consumer spending and offered a solution by approaching the conditions of depression from the demand side. The monetarist approach represented by Friedman saw the money supply contraction mentioned above as the main reason. In other words, when the Fed preferred to reduce the money supply instead of increasing it, it caused a major liquidity problem.

My personal opinion is that both basic findings are correct. However, the clear answer to the question of why the crisis occurred is found in Keynes' findings. Friedman's explanations can be the answer to the question of what aggravated the crisis that occurred. As a result, the relationship between demand and money supply is mutually affecting and the harmony of monetary and fiscal policies must be realized. It is possible to say that the conditions created by the inadequacy of demand became chronic with the contraction of the money supply since October 29, 1929, when the crisis occurred.