The Great Depression Carl Geagea Objectives Identify the

The Great Depression Carl Geagea

Objectives �Identify the macroscopic causes of the Great Depression �Establish links between the Great Depression and modern day financial crises

The Years Leading up to the Great Depression �From 1924 and onwards, America experiences a very bullish period of time �Drastic rises in stock prices are not reflective of the rest of the economy however �Government expenditures = 3 x tax revenue marked the beginning of government deficit

The Years Leading up to the Great Depression �Large corporate mergers in the 20’s result in fewer than 200 companies controlling half of US industry �Increased interdependency between these corporations results in large short term financial gains �With so few corporations, the potential for disaster is huge �The economy is a bubble ready to pop

Vicious Circle No one is safe.

Macroscopic causes of the Great Depression Bank failure Trade barriers with other countries Failure of monetary policy Black Thursday The Great Depression Poor farming conditions

Black Thursday �October 24, 1929 �Stock prices had become so artificially inflated that when people realized their stocks were overvalued, mass panic selling began �False information and limited transparency in financial figures �Many people had overleveraged themselves meaning they had borrowed money to buy the stocks

Black Thursday �Purchasing stocks on margin had the potential for disaster if stock prices went down �As long as prices continued to rise, people would make money �When stocks are purchased on margin, the person is buying stocks using loans that are only backed a small % of the stock’s value

When individuals begin liquidating, or selling stocks at a rapid pace, they often only recover a fraction of what they initially paid. The real danger arises from the fact that as stocks are sold, the supply of stocks in the market increases which drives the prices down further. The longer people hold out on selling their stocks could mean that either a) stock prices will rise and stabilize or b) prices will fall further. Declining stock prices fuel this further decline making it rather difficult to prevent wide-spread liquidation.

Black Thursday: A Blow to Aggregate Demand � Aggregate Demand = C + I + G +Xn � Increase in AD = higher price level, more output (growth), and less unemployment � The stock market crash of 1929 destroyed consumer confidence in the markets which led to a decrease in consumer expenditure � Confidence is not something that is built up over night meaning just one bad day in the stock market could effect the economy for months or even years

Black Thursday: A Blow to Aggregate Demand �For foreign investors, Black Thursday frightened them as the stock market posted such large losses in only one day �The lack of demand for US stocks further stoked this destructive wave of massing selling

Failure of Monetary Policy �As a means of trying to prevent inflated stock prices and bolster investment, the US tried to use monetary policy to raise interest rates Higher interest rates makes it harder to acquire loans and borrow money leading to less stock market speculation At the same time, investment decreases drastically as it is now harder to come by money to fund investment projects http: //www. economicsuk. com/blog/belt. jpg

Decrease in Aggregate Demand as a result of a failure in monetary policy As a result of this decrease in aggregate demand a number of elements in the economy change: 1) There is negative economic growth since the economy is only producing Y 2 instead of Y 1. 2) Unemployment rises. As you move right along the real output graph, unemployment decreases since more output means more workers are needed to produce it. 3) There is negative inflation, or deflation, of the currency. Deflation results in businesses struggling to make profits as the value of their merchandise decreases.

Bank Failure �The Federal Reserve as well as other large national banks had before relied on reducing and increasing the money supply to keep interest rates in check. � Above average foreclosure rates (farmers) kick started the eventual snowball effect. �When a bank closes, people holding money in other banks panic prompting bank runs.

Bank failure Banks only ever hold approximately 10% of all funds in their vaults. When everyone runs to a bank demanding their money back, the bank does not physically have everyone’s money. If customers demand their money, the bank has no choice but to liquidate assets rapidly to get money back into people’s hands. http: //static. guim. co. uk/sys-images/Film/Pix/pictures/2007/09/17/jamesstewart 460. jpg

Bank Failure �Rapid liquidation is equivalent to desperate selling (bad deals) which leads to massive losses which force banks to close. �Runs on banks often prevent the bank from ever doing business in the future. It is all about making bank customers feel confident in the bank’s ability to preserve their savings.

Trade Barriers with Other Countries �The US had a number of tariffs on foreign goods. Essentially, this is a tax levied on these goods if they want to be sold in the US. �During the Great Depression, US government passed the Smoot-Hawley tariff in 1930 increasing tariffs to ~60% to stimulate domestic production.

Trade Barriers with Other Countries � Other countries increased their tariffs to compete which led to a trade war and resulted in the US unable to trade with other countries, primarily Europe at this period of time. � The tariff had a devastating effect. Contracting Spiral of World Trade Resulting from Higher Tariffs

Lackluster Agricultural Production �Farmers in the midwest out on the plains began facing poor farming conditions. Over farming depleted nutrients resulting in low yields for approximately a decade. �While the production of food decreased, the real problem was the fact that farmers could not keep up with mortgage payments resulting in foreclosures.

Lackluster Agricultural Production �Banks always expect some of their customers to default on payments. The uncharacteristic poor yield of crops meant many farmers defaulted. �In the case of these defaults, the bank would repossess farms and sell them at a loss since house prices were decreasing.

The 2008/2009 Crisis �The falsification of data played a huge role in the recent US recession. �Banks (Goldman Sachs, Morgan Stanley etc. ) were selling ‘junk bonds’ to people �The value of these bonds was hugely inflated meaning once people realized how bad these bonds were, mass selling would ensue

The 2008/2009 Crisis � Even worse was the fact that these CDO’s (collateral debt obligations) were backed by house mortgages � If the CDO’s failed, the entire housing market would come crashing down with it � Banks were originating bad loans and selling the ‘responsibility’ to Freddie Mac and Fannie Mae (mortgage funders) � The two’s fates were intertwined � They either both prospered, or suffered greatly

Why Fixing an Economy is so Hard http: //tvwritingf 2011. files. wordpress. com/2011/10/house-3. jpg

Works Cited Beattie, Andrew. "What Caused The Great Depression? " Investopedia. 15 Aug. 2008. Web. 17 Apr. 2012. Carroll, Sarah. "Causes of the Great Depression. " Boston University Department of Economics. Web. 16 Apr. 2012. "Causes Of The Great Depression | Causes, Effects, Timelines. " Causes Of The Great Depression. Web. 17 Apr. 2012. Romer, Christina D. "Great Depression. " University of California, Berkeley. 20 Dec. 2003. Web. 19 Apr. 2012.