The US Economy In The Great Depression

It is undeniably the most devastating economic event in the history of humankind: the United States, one of the world's leading economic powers, experienced collapse. Unemployment soared, peaking at 24.9% — nearly a quarter of the country's work force - in 1933. And perhaps even more appalling was the essential demise of the stock market: from 1929 to 1933, the Dow Jones Industrial Average, the leading indicator of corporate health in the United States, lost 89.5% of its value.

Surprisingly, the roots of the Great Depression can be traced back to foreign exchange. Throughout the 1920s, Great Britain, as well as the majority of the rest of the world, lobbied to have the pound attached to a gold standard. As the world's currency of choice for international transactions, the world saw benefit in attaching its value to gold: by making the two exchangeable, international trade would greatly be facilitated.

In order to make this happen, Ben Strong of the US Federal Reserve Bank of New York sought to weaken the US dollar against the pound in order to cement the pound's status as the world's leading currency. Thus in 1925, at the coaxing of Montague Norman, Governor of the Bank of England, Strong cut interest rates - in spite of the fact that the US economy was already thriving in the midst of a stock market boom. This was, essentially, analogous to fueling a flaming fire: the stock market rose considerably once again, and continued to set new highs.

At England's request, Strong made another rate cut in 1927. This created a stock market that was enjoying unprecedented growth, and one that could cheaply be fueled in light of how readily accessible money was. Unsurprisingly, margin trading flourished at this time, as speculators entered the market using borrowed funds.

In fact, growth was so fast that even the continued decrease in interest rates - which essentially served to increase the accessibility of money - proved to be insufficient: demand was so high that not even repeated interest rate cuts could satisfy it, and hence the economy began to suffer from an imbalance between supply and demand of money. In such a scenario, one in which supply cannot meet demand, deflation - or the rapid falling of prices - sets in. As a result of falling prices, the Dow Jones collapsed, falling 40% in a matter of 56 days.

This, in turn, set the stage for a full blown banking crisis. With assets falling in value, banks were unable to collect from those they had lent to, and thus banks collapsed. With banks lending to other banks, the spiral snowballed, and the backbone of the entire US capitalist enterprise was suddenly on shaky ground. On top of this, the US government soon decided to raise taxes, thereby decreasing the amount of disposable incoming and increasing the level of risk aversion in an environment that had already become excessively contractionary.

As a result of its plummeting domestic economy, the US' international trade balance diminished in size as well. The weakness of the US economy prohibited it from continuing to import products as it had in the past, and hence countries overseas responded withdrew from trade relations as well. Ultimately, the world devolved into adopting more protectionist policies, and implemented tariffs as well.

For the US dollar, its value had diminished to unfathomable lows. Deflation had essentially nullified the value of everything; as a result, the US economy was left with little mercantile ground to stand on, both domestically and abroad as well. It was not until World War II and President Franklin Delano Roosevelt's New Deal Policy that the US economy was able to use social spending as a means of combating unemployment and stimulating entrepreneurial endeavors.

Once the US economy had rebuilt itself through a robust government funding bordering on socialist policies, the US was able to re-enter the business of international trade. Having learned from the catastrophe, the US government decided to insure US banks against such calamities, thereby ensuring that structure of the entire economy would always remain in reasonable health. As for monetary policy, the Federal Reserve learned to use supply as a tool to moderate demand - regardless of what international trade objectives may be at hand.