The Great Depression — why the lessons learned are more relevant than ever
Today we’re continuing to explore significant moments in financial history. In particular, I’m aiming to arm you with a basic understanding of what the event was all about, and then importantly, why it’s of relevance today.
Last week we looked at Tulip Mania in the Netherlands in the 1600s. Today we skip forward several centuries to the Great Depression of the late 1920s and 1930s.
The Great Depression remains the longest and most serve economic collapse in modern history. There is some variation across countries, but it is generally considered to have lasted 10 years, from 1929 to 1939, though for many countries directly impacted by World War2, their struggles were further prolonged.
Prices fell, unemployment skyrocketed, and global economic output shrank dramatically.
To appreciate the scale, in the US, between 1929 and 1933, economic production declined 30% and unemployment exceeded 20%. During the GFC in 2007–2009 — US economic output dropped a little over 4%, whilst unemployment topped out at 10%.
In Australia, the depression hit its low point in 1932 with unemployment reaching an astounding 32%.
So what preceded this extraordinary period of hardship?
The rebuild of Europe following the end of World War 1 resulted in a booming global economy for much of the 1920s, leading to the period being tagged the “Roaring 20's”. The United States in particular enjoyed unprecedented prosperity. As incomes rose, share market investing became common, causing markets to rise strongly. Emboldened by these rapid gains, and enabled by banks with surplus cash to lend, borrowing to buy more shares flourished.
But as the decade approached a close, fortunes were starting to turn.
There is no consensus on a single cause of the Great Depression however two factors unquestionably played a significant role.
The surplus of agricultural output in the latter part of the 1920s caused the price of goods produced by farmers to drop. Bowing to political pressure, the United States government imposed tariffs averaging 20% on a wide range of agricultural and industrial imports with the aim of protecting local producers. Not surprisingly, this action resulted in other countries imposing retaliatory measures, and many imported items needed by the US became more expensive, hurting profitability. This trade war is considered a key factor in setting the scene for the collapse to come.
The second factor widely acknowledged as a key ingredient was the Gold Standard. I plan on exploring the Gold Standard in the next post in this series, but for now, it’s enough to know that most countries’ currencies were exchangeable for a certain amount of physical gold. This mechanism had the unintended consequence of transmitting the economic woes of one country, across into other countries due to the common linkage to gold and the inflexibility of the rate with which currencies and gold could be exchanged.
The Gold Standard was an important contributor to Australia’s woes. In 1925, Winston Churchill returned the British Pound to the Gold Standard. As Australia’s currency was pegged to the British Pound, so to we too became tied to the value of gold. The British pound became overvalued, making both British and Australian exports too expensive on world markets. The value of Australia’s two main exports — wheat and wool — halved in 1929 and 1930.
Tariffs and the Gold Standard set the scene for the Great Depression, but it was the US Stock Market crash of October 1929 that was the match to set the bonfire alight.
On September 3rd, 1929, the Dow Jones index closed at 381.7 points. It would not reach that level again for 25 years. The market bottomed on the 8th of July 1932 at 41.22, a 90% decline from the pre-crash high.
The fallout was widespread. Just in the year 1930, 1,300 US banks went broke, vaporising their depositor’s savings.
In response, the US government implemented a range of policies which almost universally made things worse. The wisdom of the day was that everyone just needed to live within their means — governments as well as citizens. Government spending was cut, and taxes raised. Foreign trade was largely frozen, and US investment into other countries, a previously important source of funding for many countries (such as Australia), dried up. In this way, many consider that the US exported the depression to the rest of the world.
These government policies were replicated around the world. Australia even invited an “expert” from Britain to advise on the best approach. His prescription was to pay down debt (much of it owed to British banks), reduce spending, and essentially, get your house I order.
As it became obvious these policy prescriptions weren’t working, countries looked for alternatives. An early casualty was the Gold Standard, that mechanism that linked the countries to one another, and prevented governments from increasing their money supply to stimulate economic activity.
Britain was one of the first to abandon the Gold Standard in 1931. Australia and Canada immediately followed. The US discarded it two years later.
In the US, Franklin D Roosevelt’s New Deal commenced in 1933. He ended prohibition, and instead imposed taxes on alcohol. Government construction projects began, creating thousands of jobs. Twelve majors laws were introduced in his first 100 days in office, and then, in 1935, with unemployment continuing to a be problem, further programs were introduced to create government jobs for the unemployed, union membership was made easier, and social security was introduced guaranteeing aged pensions and providing unemployment benefits.
Ultimately, spending or armaments and the commencement of World War 2 brought the Great Depression to an end — even the strictest of economic conservatives wouldn’t argue against their country spending money defending itself.
So why does this piece of history matter to us today?
After the Great Depression, governments of both left and right persuasion recognised that a key role of any government was to pursue policies that would lead to full employment. This is very much evident today, with our Reserve Bank cutting interest rates to record lows just recently, entirely in pursuit of this aim.
Our entire approach to economic declines is shaped by the experiences of the Great Depression — when economies fall into a slump, governments run deficits and spend money. Who can forget the free $1,000 handouts to all taxpayers in 2008?
Our Social Security system was born out of the pain of the 1930s. After World War 2, unemployment and sickness benefits were introduced into Australia nationally, replacing previous state-based schemes that had been designed merely to avoid starvation (if you owned a home you were excluded for instance).
Floating exchange rates, though rolled out at varying times around the world, have allowed countries to adjust their relationship with the outside world with far less pain and friction than was the case before the Great Depression.
And the lessons are as relevant today as they have ever been. Rising tariffs and trade disputes were a key ingredient in setting the scene for the Great Depression. The current US administration seems intent on starting a trade war with China by increasing tariffs, something we should all be concerned about. Indeed this may be why central banks around the world have been starting to cut interest rates again, even though there is no recession in evidence — they’re trying to get in early and offset the damage they can see coming down the road due to these harmful trade policies.
An interesting side note to wrap the episode up is the story of Charles Darrow. He was born in 1889, and like many, found himself unemployed following the Wall St crash in 1929. He worked at various odd jobs to support his family. He observed friends and neighbors playing real estate trading games, which lead to him creating his own. He called it Monopoly. Parker Brother ultimately acquired the rights to the game, and Darrow became the first-ever millionaire game designer.
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