USM Open Source History Text: The World at War: World History 1914-1945

The Great Crash and Global Slump (1929 – 1932)

The Great Crash came during an era of industrial expansion, but this expansion was not mirrored in all aspects of the U.S. economy. Industrial expansion and technological improvements had facilitated efficiency resulted in over-production because demand could not keep up with supply. A fall in demand left industries with burdensome surpluses and declining profits. Producers of goods scaled back. Workers were laid off. Factory output lessened. Wages fell. Falling employment and wages further suppressed manufacturing, which meant more job loss. Added to this picture, the agricultural sector since WWI had become increasingly hard hit as the prices for grains and other commodities fell.

By 1929, the business environment in the United States was unhealthy. In the years before the Great Crash, businesses and individuals tried to make up for economic shortcomings through debt and speculation. Businesses began to borrow money from banks, betting on future profits. Investment bankers and individuals began to put money into the stock market with the idea that the market would keep increasing in value - a strategy that led to an investment bubble. Many of these stock investments were made on margin, meaning that people paid only a fraction of the value of the stock, at times as low as 10%. Investing on margin was a dangerous game, because people could then count the stocks they owned as assets worth their full value, even when they had only paid for a fraction of them. These theoretical assets could then be used as collateral to buy more stocks on margin. This system worked fine if the stocks held their value, but proved disastrous in more volatile market conditions.

The perfect storm was set. The U.S. economy was experiencing overproduction, under-consumption, massive personal and corporate debt, and a speculative bubble holding the entire economy above water. The thing about buying stocks on margin is that in order to avoid losing more money than you have, you have to try to sell out as early as possible if the stock starts dropping. On the other hand, if you own the full value of a stock, you could let it drop pretty far in hopes that it would someday come back up. The people who bought on margin didn’t have this luxury and thus, when stocks started dropping in October of 1929, there was a rush to sell before they lost more than they had. This proved impossible and all of a sudden the United States’ economy was faced with a terrible situation: people owed investment brokers hundreds of millions for the lost value of stocks they had purchased on margin. In order to pay for this lost value, people and corporations were forced to withdraw money from the banks. Fear that banks would run out of money caused rapid withdrawal of funds, putting the banking system under dire stress.

Bankers, fearing insolvency, called in their corporate loans. This means that they asked big businesses to repay the money they had borrowed earlier to fund expansion and technological innovation. Because production had fallen and profits were down, few businesses could meet their debt obligations to the banks. If we add to this all of the individual home-owners and, especially, new car owners, who had combined borrowed to finance purchases, then we find an astonishing amount of unpaid debt throughout the economy. This debt crushed the United States’ banking system. As we learned earlier in the chapter, the United States had become the world’s creditor, effectively holding the European economy in a state of stable equilibrium by issuing massive loans. When U.S. private lenders withdrew their support from the European economy, the financial world collapsed. Loans became impossible to make. No new loans meant no new business, no expansion of old business, a steady fall in consuming, and a rapid loss of jobs. The entire economy of the world was in free fall.

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