Chapter 47 [The 1929 Great Depression: Causes, Process, and Results, Part 3]

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[James Origins and Today] Chapter 47 - The 1929 Great Depression: Causes, Process, and Results, Part 3 (07/05/2023)

The Keynesian view

Keynes's basic idea was simple: to keep people fully employed, the government must run deficits during an economic slowdown, because private-sector investment is not enough to keep production at normal levels and pull the economy out of recession. Keynesian economists called on governments to make up the shortfall during economic crises by increasing government spending or cutting taxes.

As the Great Depression continued, Franklin D. Roosevelt tried public works, agricultural subsidies, and other means to restart the U.S. economy, but he never completely gave up the effort to balance the budget. According to Keynesians, this improved the economy, but Roosevelt did not spend enough to pull the economy out of recession until the beginning of World War II.

The result of the 1929 Great Depression: debt deflation

During the 1929 crash before the Great Depression, margin requirements were only 10%. In other words, brokerage firms would lend $9 for every $1 an investor deposited. When the market fell, brokers called these loans, and the loans could not be repaid. Banks began to fail because debtors defaulted, while depositors tried to withdraw deposits in large amounts, triggering multiple bank runs. Government guarantees and Federal Reserve banking regulations meant to prevent such panics were ineffective or unused. Bank failures caused billions of dollars in asset losses.

Outstanding debt became heavier because asset values and income fell 20-50%, while debt remained the same dollar amount. After the panic of 1929 and during the first ten months of 1930, 744 U.S. banks failed. (In the 1930s, a total of 9,000 banks failed.) By April 1933, about $7 billion in deposits were frozen in failed banks or in banks that had not been licensed after the March bank holiday. Bank failures snowballed as desperate bankers demanded repayment of loans that borrowers had neither the time nor the money to repay. Because future profits looked poor, capital investment and construction slowed or stopped entirely. Facing bad loans and a worsening outlook, surviving banks became more conservative in lending. Banks increased capital reserves and reduced loans, which intensified deflationary pressure. A vicious cycle developed, and the downward spiral accelerated.

Debt liquidation could not keep up with the price declines it caused. The large-scale effect of stampede-like liquidation increased the value of every dollar owed relative to the falling value of asset holdings. Efforts by individuals to reduce their debt burdens effectively increased those debt burdens. Paradoxically, the more debtors paid, the more they owed. This self-intensifying process turned the 1930 recession into the Great Depression of 1933.