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The Great DepressionCarl GeageaObjectivesIdentify 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 DepressionFrom 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 howeverGovernment expenditures = 3 x tax revenue marked the beginning of government deficit

The Years Leading up to the Great DepressionLarge corporate mergers in the 20s result in fewer than 200 companies controlling half of US industryIncreased interdependency between these corporations results in large short term financial gainsWith so few corporations, the potential for disaster is hugeThe economy is a bubble ready to popVicious Circle

No one is safe.Macroscopic causes of the Great DepressionBlack ThursdayOctober 24, 1929 Stock prices had become so artificially inflated that when people realized their stocks were overvalued, mass panic selling beganFalse information and limited transparency in financial figuresMany people had overleveraged themselves meaning they had borrowed money to buy the stocksBlack ThursdayPurchasing stocks on margin had the potential for disaster if stock prices went downAs long as prices continued to rise, people would make moneyWhen stocks are purchased on margin, the person is buying stocks using loans that are only backed a small % of the stocks valueWhen 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 DemandAggregate Demand = C + I + G +XnIncrease in AD = higher price level, more output (growth), and less unemploymentThe stock market crash of 1929 destroyed consumer confidence in the markets which led to a decrease in consumer expenditureConfidence 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 yearsBlack Thursday: A Blow to Aggregate DemandFor 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 sellingFailure of Monetary PolicyAs a means of trying to prevent inflated stock prices and bolster investment, the US tried to use monetary policy to raise interest rates

http://www.economicsuk.com/blog/belt.jpgHigher 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 projectsDecrease 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:

There is negative economic growth since the economy is only producing Y2 instead of Y1.

Unemployment rises. As you move right along the real output graph, unemployment decreases since more output means more workers are needed to produce it.

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 FailureThe 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 everyones money.

If customers demand their money, the bank has no choice but to liquidate assets rapidly to get money back into peoples hands.

http://static.guim.co.uk/sys-images/Film/Pix/pictures/2007/09/17/jamesstewart460.jpgBank FailureRapid 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 banks ability to preserve their savings.

Trade Barriers with Other CountriesThe 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 CountriesOther 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 ProductionFarmers 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 ProductionBanks 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 CrisisThe falsification of data played a huge role in the recent US recession.Banks (Goldman Sachs, Morgan Stanley etc.) were selling junk bonds to peopleThe value of these bonds was hugely inflated meaning once people realized how bad these bonds were, mass selling would ensue

The 2008/2009 CrisisEven worse was the fact that these CDOs (collateral debt obligations) were backed by house mortgagesIf the CDOs failed, the entire housing market would come crashing down with itBanks were originating bad loans and selling the responsibility to Freddie Mac and Fannie Mae (mortgage funders)The twos fates were intertwinedThey either both prospered, or suffered greatly

Why Fixing an Economy is so Hard

http://tvwritingf2011.files.wordpress.com/2011/10/house-3.jpgWorks CitedBeattie, 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 | 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.