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The Stock Market Crash, the Great Depression, and the New Deal
VUS.10 ~ What were the causes and consequences of the stock market crash of 1929?
~ What were the causes of the Great Depression and what was its impact on the American
people?
~ How did Franklin D. Roosevelt’s New Deal relief, recovery, and reform measures address
the Great Depression and expanded the government’s role in the economy?
The Great Depression was a period of severe economic hardship lasting from 1929 to World War
II. A combination of factors caused the Great Depression. Three of the most important causes were: 1)
the 1929 stock market crash and the resulting collapse in stock prices, 2) the Federal Reserve’s failure to
prevent widespread collapse of the nation’s banking system in the late 1920s and early 1930s, leading to
severe contraction in the nation’s supply of money in circulation, 3) High protective tariffs like the HawleySmoot Act (Tariff Act of 1930) that produced retaliatory tariffs in other countries, which strangled world
trade.
The United States emerged from World War I as a global power. Since American business was
booming during the early twenties, great optimism existed about the future of the American economy and a
stock market boom resulted. These factors led to an excessive (too much) expansion of credit, which in
turn led to investments made with borrowed money. Unfortunately, investment with borrowed money led to
overspeculation in the stock market.
Speculation is the act of buying something at a low price in the hope of reselling it later at a profit.
One way people make money off stocks is through speculation. They buy them at one price. Then when the
stock’s price goes up, they sell their stock at a profit. Between 1920 and 1929 prices on the New York
Stock Exchange, the nation’s largest stock market, steadily increased. As a result, stock market
speculators became very wealthy. Many of them realized if they borrowed money, then they could buy even
more stock. After these investors sold their stock, they could repay their loans and still clear larger
profits. This practice of buying stock on credit was called buying stock on margin. Margin buying led to
overspeculation in the stock market. When the market dropped, investors who had bought stock on credit
found themselves in a difficult position. The terms of their loans allowed their creditors to demand enough
money to cover the stock’s original value. This forced investors to sell even more stock, which caused
stock prices to drop even further. This downward cycle continued until the New York Stock Exchange
crashed, and stock prices completely collapsed.
The 1929 stock market crash had several causes. Overspeculation fueled by the excessive
expansion of credit was one cause. Second, business failures led to bankruptcies. Third, since bank
deposits were often invested in the stock market, the banks had no money, when the market collapsed.
When businesses failed, the stocks lost their value, prices fell, production slowed, banks collapsed, and
unemployment became widespread. As a consequence of the stock market crash, clients panicked,
attempting to withdraw their money from the banks, but there was nothing to give them. No new
investments occurred, and business plummeted (nose-dived). This downward business cycle occurred
despite the preventive actions taken by the Federal Reserve System.
The Federal Reserve System functions as the central bank of the United States. The Federal
Reserve Act created the Federal Reserve Bank system in 1913. This law divided the United States into
twelve Federal Reserve districts, each of which possesses a Federal Reserve Bank. A Federal Reserve Bank
is a banker’s bank. Only banks can have accounts at a Federal Reserve Bank. If a bank needs to borrow
money, it may do so from the Federal Reserve Bank. However, a bank must pay interest on its loans from
the Federal Reserve, just as individuals must pay interest if they borrow money from a bank. The Federal
Reserve Board, appointed by the President of the United States, oversees the actions of the Federal
Reserve Banks and sets the interest rate which banks must pay to borrow money from the Fed. The
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Federal Reserve’s power to set interest rates enables it to control the nation’s money supply. If the
Federal Reserve Board believes the American economy is slowing down, it will cut interest rates and
thereby encourage borrowing. On the other hand, if the Federal Reserve Board believes the economy is
overheating and thereby causing inflation, then it will raise interest rates. (Inflation means prices
increase, and the dollar buys less.)
When the stock market crashed in 1929, the Federal Reserve Board was unable to prevent it from
triggering the Great Depression. During the twenties, many banks had invested their savings deposits in
the stock market. They had also loaned money to speculators who were buying stock on credit. When the
market crashed, these individuals could not cover their loans. As a result, the banks lost the money, which
they had loaned for stock speculation. Although the Federal Reserve Board had recognized in the late
twenties that speculation was out of control and had tried to adjust interest rates accordingly, it could not
protect individual banks from their unsound loan policies. Once banks began to fail, Americans began to
lose confidence in the nation’s entire banking system. Thousands of Americans rushed to withdraw their
savings from the banks, before they closed. This action placed even more pressure on the nation’s banks.
As a result, during the first three years of the Great Depression, five thousand banks failed and nine
million Americans lost their savings accounts. The Federal Reserve’s failure to prevent widespread collapse
of the nation’s banking system in the late 1920s and early 1930s led to a severe contraction (reduction) in
the nation’s supply of money in circulation.
High protective tariffs also helped cause the Great Depression. A protective tariff is a tax on
imports that is so high that Americans cannot afford to buy foreign goods. After the 1929 stock market
crash, Congress attempted to help American business by passing the Tariff Act of 1930, which was
popularly called the Hawley-Smoot Tariff. Since the Hawley-Smoot Tariff was a protective tariff that set
the highest tariff rates in American history, historians now believe it actually had the opposite effect
from what Congress intended. Instead of helping business by encouraging Americans to buy Americanmade goods, the Hawley-Smoot Tariff encouraged foreign countries to retaliate (strike back) by passing
high tariffs of their own. This meant that foreigners could not afford to buy American goods. In short,
the erection of tariff barriers by all of the world’s major industrial powers strangled world trade. This
decrease in world trade deepened the worldwide depression.
The Great Depression caused widespread hardships in the United States. It had a five-pronged
effect on the United States. First, unemployment skyrocketed and homelessness increased. By 1932
twelve million Americans were out of work, and the unemployment rate stood at twenty-five percent of the
American work force. Second, bank closings led to a near collapse of the nation’s financial system. Third,
the demand for goods declined. As people became unemployed, they had less money to spend, which
resulted in a sharp decline in the demand for goods and services. Fourth, business bankruptcies, increased
unemployment, and bank closings led to political unrest. Labor unions especially became more militant
(confrontational), and some even questioned whether capitalism was the best economic system for the
United States. Fifth, as the Great Depression worsened, banks foreclosed on thousands of farms. These
farm foreclosures caused thousands of farm families to migrate (move away) from the lands of their birth.
They traveled in search of jobs, which often did not exist.
Most Americans blamed President Herbert Hoover, a Republican, for the terrible conditions of the
Great Depression. Consequently, in the presidential election of 1932
the Democrat candidate Franklin Delano Roosevelt (FDR) overwhelmingly defeated President Hoover’s bid
for re-election. At his inauguration, Roosevelt tried to rally the American people by telling them, “This is
pre-eminently the time to speak the truth, the whole truth, frankly and boldly. Nor need we shrink from
honestly facing conditions in our country today. This great nation will endure as it has endured, will revive
and will prosper. So first of all let me assert by firm belief that the only thing we have to fear is fear
itself.”
President Roosevelt offered a “New Deal” for the American people. The New Deal was FDR’s
program to end the Great Depression. This program changed the role of the government to a more active
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participant in solving the nation’s problems. The power of the federal government increased, and Americans
came to expect the federal government to take responsibility for bringing prosperity to the American
economy. The New Deal followed a three-pronged strategy, often called the “three R’s.” These three R’s
were relief, recovery and reform.
Relief programs tried to ease the suffering of the unemployed. Relief measures, like the Works
Progress Administration (WPA), provided direct payments to people for immediate help. Many of these
were public works programs. Public works are construction projects that benefit the whole society, like
highways, bridges, schools, post offices, and parks. The federal government hired unemployed Americans
who could not find jobs. Recovery programs aimed to bring about the recovery of business in all areas of
the American economy. They were designed to bring the nation out of depression over time. For example,
the Agricultural Adjustment Administration (AAA) tried to help farmers recover from the depression by
limiting agricultural production and thereby raising livestock and crop prices.
Reform programs attempted to bring about change for the better in American society. Some
reform programs tried to help prevent future economic crises, by correcting unsound banking and
investment practices. One program in this category was the Federal Deposit Insurance Corporation (FDIC),
which protects the money of depositors in insured banks. Other reform programs tried to provide a
degree of financial security for the neediest Americans. For example, the Social Security Act offered
safeguards for workers, including unemployment insurance and retirement benefits. Americans came to
believe that American society should use the federal government to provide care for those Americans, who
through no fault of their own could not take care of themselves.
Although the Great Depression did not end until World War II, the New Deal provided hope for
millions of Americans during one of the most difficult decades in American history. The New Deal also had
lasting results. It permanently changed the role of the American government in the economy. The New
Deal also fostered (encouraged) changes in people’s attitudes toward government’s responsibilities.
Organized labor (unions) acquired new rights, like the right to form a union, the right to strike, and
minimum wage. Finally, the New Deal set in place federal legislation that reshaped modern American
capitalism. In short, the legacy (lasting effect) of the New Deal influenced the public’s belief in the
responsibility of government to deliver public services, to intervene (get involved) in the economy, and to
act in ways that promote the general welfare.
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