Thursday, October 9, 2008

Great Depression Revisited

There is no other time better than now to revive the issue of Great Depression, given that the world largest economy is imminently moving towards that direction. It an Armageddon & a day that all those who went through it will not forget.

What is Great Depression?

The greatest worldwide economic downturn that began in 1929 & lasted for about 10 years in US. It is often associated with the memorable date of October 29 or the Black Tuesday, the day where stock market suffered the biggest blow. Since then, this event has been used in the 21st century as a benchmark on how far world’s major economy can fall

What happen that time?

US’ GDP fell from $103 billion to $55 billion as industrial production slows down significantly. Unemployment rose from 3% to 25% & this was partly exacerbated by the world trade that plummeted by 65% around that time. Suicide rate increase from 14 to 17 per 100, 000

Major causes

(1) Restrictionary monetary policy. All thanks to the tight monetary stance instituted by Federal Reserve at that time. To prevent inflation, interest rates were raised several times & unfortunately the financial market did not positively digest this. This led to the stock market crash in October 1929. As the market was not performing, investors turn their money onto currency markets. That time, dollars were backed by gold. Speculators began heavily selling dollars for gold, & this caused major depreciation of dollar.

The Fed then raised interest rates again to preserve the value of dollar & this deepened the crisis. Further restrictions in availability of money for businesses lead to more bankruptcies. Industrial production fell by 9% between October & December 1929 & this instantly led to large scale unemployment. More people began to default in their loan. In the same period stockholders lost more than US$ 40 billion

(2) Fall in spending across economy. Closely related to the first point. With the fall in wealth & declining economic confidence, people & firms immediately cut their spending into the economy. This led to reduction in number of goods produced & thus a further cut in employment. As more people lost their jobs, more ran into bad debts & this hurt the balance sheet of their company. Fall in profitability forced those existing firms to cut employment again (cycle repeat itself). Unemployment rose to 25% at the height of the Depression

(3) Failure of banks. In the 1930s, more than 9000 banks failed. That time, there were no such thing as guaranteeing the deposits. Therefore as banks collapsed people simply lost their savings. Surviving banks surrounded by pessimism began to tighten the condition for lending & this exacerbate the situation by the way of falling consumption expenditure & investment

(4) Smoot-Hawley Tariff. The government created this act with the intention to insulate & revive American companies from competition outside. Also it is hoped that it will generate employment opportunities once those industries get back on their feet. Under this act, higher tariffs will be imposed onto imported goods that come into US causing them to be more expensive. Consumers will be forced to consume local goods

Unfortunately, others also retaliate by imposing high tariffs on US good. Exports fell. Manufacturing sector was sent to recession. Therefore the intention to create jobs failed

(5) Unbalance concentration of economic activity. It is argued that the government should diversify the economic activity. The Federal government that time favoured new modern industries than agriculture. Somehow during World War I, they had taken bold move to subsidise farm, paid absurdly high prices for wheat, encouraged more of them to buy land, equip those farmers with modern production techniques etc. This was all part of the food security program. After the war end in 1918, these farmers were treated like ‘step-son’. Price paid for farms’ output fell tremendously. Many were in left great debt.

Too much of concentration were given to rising industries such as automobile & radio. As such when those two collapsed during the wrath of Great Depression, the whole US economy follow suit (Like I said in class, never put all eggs in one basket!)

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