Question

Discuss the causes of the Great Depression in terms of what you know about the economy today. Do you think another Great Depression is possible? Why or why not?

Answer 1

The 1929 stock-market crash. The U.S. stock market was undergoing a historic expansion in the 1920s. When stock prices soared to unprecedented levels, stock market investment was seen as an easy way to make money, and even ordinary people used much of their disposable income to buy shares or even mortgaged their homes. Hundreds of millions of shares were carried on margin by the end of the decade, meaning their purchase price was financed with loans to be repaid with profits from ever-increasing share prices.The effect was a deep psychological shock and a loss of consumer and business confidence in the economy. Consumer spending, especially on durable goods, and business investment have been drastically curtailed, resulting in reduced industrial output and job losses, further reducing spending and investment.

Panics in banking and currency contraction. The United States witnessed four widespread banking panics between 1930 and 1932, during which large numbers of bank customers, afraid of the solvency of their account, simultaneously tried to withdraw their deposits in cash. Ironically, the frequent effect of a banking panic is to bring about the very crisis that panicked customers are trying to protect themselves against: a large panic can ruin even financially healthy banks. The decreased supply of money in effect lowered prices, further restricting borrowing and investment (because people feared that potential income and earnings would not be enough to cover loan payments).

The standard of gold. Whatever its effects on the money supply in the US, the gold standard undoubtedly played a role in spreading the Great Depression from the US to other countries. As the US experienced declining output and deflation, it tended to have a trade surplus with other countries because Americans bought less imported goods, while American exports were relatively cheap Just as there is no general agreement on the causes of the Great Depression, there is no consensus on the origins of recovery, although some factors have again played an obvious role. Generally speaking, countries that abandoned the gold standard and devalued their currencies or otherwise expanded their money supply first recovered (Britain abandoned the gold standard in 1931, and the US eventually devalued its currency in 1933).

Depression may result from stock market crashes by wiping out the life savings of investors. If people have borrowed money to invest, then all they have to pay back the loans will be forced to sell. By this leveraging, derivatives make any crash even worse. Crashes also make it hard for businesses to raise the funds they need to grow. Finally, a stock market crash may destroy the trust needed to get the economy back on track.

Higher housing prices and consequent foreclosures totaled at least $1 trillion in losses on the secondary market to lenders, hedge funds, and other holders of subprime mortgages. While housing prices have risen, banks continue to hoard cash. The losses from one million foreclosures are still being digested.
Business credit is necessary for companies to continue to operate on a daily basis. Small businesses can not expand without credit, stifling the 65% of all new jobs they create.