Worst Economic Meltdown: The Great Depression

Worst Economic Meltdown: The Great Depression

Prepared for

Lee Kuhnle

Instructor – ECON 3000-0LF

November 7th, 2014

Prepared by

Kamil Zora

Table of Contents

Introduction 3-4

Problems/Key Issues 3-4

Question Responses 5

Strategy for Changing Importance of Attributes 5-6

Strategy for Changing Brand Beliefs 6-7

Strategy for Adding a new Attribute. 7-8

Evaluation of Marketing Tactics 8-9

Reccomendations 9-10

References 11

Appendix 12

Introduction

The Great Depression was the longest lasting and most devastating recessions to ever happen in the history of the world. The reach of its affect included everyone from individuals,

households, investors, traders, and businesses. Prior to the great depression, the economy was at its best, the labor force was doing pretty well, the stock market was booming, the tax rate was lowered, so what went wrong? Well It is identified that all the factors that made the economy 'roar' came with a side effect.
During this tragic period, businesses were quickly going bankrupt, unemployment was at an all time high which lead to an epidemic of malnutrition, starvation and poverty.

People had their livelihoods completely changed in a matter of days. Unemployment in 1929 was at a healthy 3.5% and in 1933, reached an all time high of 25%. This recession was like no other, fueled by a variety of factors such as: the inattention and lack of analysis to the prior bank failures that were multiplying by the year , "Worse was to come. Bank failures came in waves. The first, in 1930, began with bank runs in agricultural states such as Arkansas, Illinois and Missouri. A total of 1,350 banks failed that year." issues with the gold standard, the Smoot-Hawley tariff and Tax increases that were counter reactions that failed by the Hoover Administration, and the stock market

crash.
The peak years of the Great depression were between 1929 to 1933, these are times where all the events fuelled together and destroyed the economy. Many economists have their own view of what and how the depression came to occur, and why it was the most tragic of all recessions. The theory developed by Friedrich von Hayek focuses on the financial crises relating to a credit/lending factor. While the most popular at that time, John Maynard Keynes, developed a theory that was centered around the money supply, consumer spending and how the government can easily reverse this recession. The examination of these two different points of views will be discussed and analyzed.
Major Causes of the Great Depression
Bank Failures
The Great Depression was fuelled by four major events that were considered turning points for the economy.

Banks were failing by the thousands and the federal reserve had failed to acknowledge this failure prior to the depression. Many of these banks were local banks that were lenders to the people in their areas. This wave of bank failures was an early indication that a huge recession was about to hit the economy. These banks that had previously failed prior to 1929 were all local banks which serviced people in their local region, the failures were getting stronger and stronger and banks had to shut down because of the lack of confidence in the system and major bank runs. In 1929, 650 banks were reported shut down, by 1933, 4000 banks were out of business. Americans were living on credit they did not

have.
Too many loans were being given out, Americans were buying things on credit they didn't have. As loans were being given out, the money supply and inflation increased, but soon after, the loans could not be paid back due to a decrease in employment, this caused the money supply to decrease and deflation to increase. At this time people began to lose faith in the banking system and a series of bank runs struck banks throughout the nation leading to bank panics and finally leading to Bank failures. People were withdrawing excessively which caused the bank's reserves to greatly decrease which took them out of business, taking a huge loss; from their loans that were defaulted and from their depositors who withdrew excessively at one time. "Nearly 11,000 banks had failed between 1929 and 1933, and the money supply dropped by over 30%. Unemployment, just 3.2% on the eve of the crisis rose to more than 25%." (The Economist). At the time where loans were being given out, the economy looked healthy, fueled by the roaring 20's and innovations. This picture-perfect economy lead the banks and people to think the economy will continue to boom and the possibility of recession was very small. The collapse of the farming industry and production was quickly happening. As these industry began to see a drop in consumer spending, they had to decrease output by laying off workers which caused the unemployment rate to greatly increase. A diagram included to summarize the impact the banks failure had on the economy during the great depression.
'Loans Cannot be paid $ Supply Decreases, Deflation Increases.'
'$ Stock Fell + $ Spent on G&S Fell Firms Cut Prices & Reduce Output = Unemployment Increases, Productivity Decreases.'
Hoover's Mistakes: Smooth Hawley Tariff Act and Tax Increases
During his presidency, Hoover's office made 2 tax changes to help slow down the great depression. Firstly, he imposed a tax increase on imports and his second decision was to increase taxes on the wealthy of America, consequently damaging production and international trade relations.
Although not considered a cause, this act had an impact and added fuel to the fire during the great depression. "The Smoot-Hawley tariff act was more a consequence of the onset of the Great Depression than an initial cause. But while the Tariff might not have caused the depression, it certainly did not make it any better." (Smooth-Hawley Tariff). The act was introduced to keep spending in America, and increase the GDP. The act imposed a 25-50% tax rate on imported goods, this caused out siding nations to retaliate and impose their own tariffs, which put a barrier on international trade and country relations. This act cut out international trade, and it became a time where each nation was to worry about themselves. Other nations reacted to this act by passing similar acts in their countries. For countries like Chile at that time, copper was their main export, and their dependence on America as a buyer, selling 80% of their copper to the States. This act and the industrial crash meant Chile's economy was no more.
Such policies contributed to a drastic decline in international trade. For example, U.S. imports from Europe declined from a 1929 high of $1,334 million to just $390 million in 1932, while U.S. exports to Europe fell from $2,341 million in 1929 to $784 million in 1932. Overall, world trade declined by some 66% between 1929 and 1934. More generally, Smoot-Hawley did nothing to foster trust and cooperation among nations in either the political or economic realm during a perilous era in international relations. (U.S Dept of State. 2014).
To help fix the economy, in 1932 Hoover's office imposed a new tax act that would tax the wealthy of America and help clear the debt deficit. This increase was excessive and is proven to have more of a negative affect rather than a positive. The income tax for top earners in America was raised from 25% to 63%, as well as corporate taxes were increased. The implications this had was that it provided less incentive for people to be productive. Going back to capitalism and it's development of 'Private Property' it is known that the law of Private Property gives incentive for people to create and innovate. Being taxed 63% of your income is relative to being stripped of your private property rights, you just do not want to work as harder. This is what slowed economic growth. Corporations and the wealthy had less incentive to earn and innovate.
The range of tax increases was enormous. Many wartime excise taxes were revived, sales taxes were imposed on gasoline, tires, autos, electric energy, malt, toiletries, furs, jewelry, and other articles; admission and stock transfer taxes were increased; new taxes were levied on bank checks, bond transfers, telephone, telegraph, and radio messages; and the personal income tax was raised drastically as follows: the normal rate was increased from a range of 1? percent-5 percent, to 4 percent-8 percent; personal exemptions were sharply reduced, and an earned credit of 25 percent eliminated; and surtaxes were raised enormously, from a maximum of 25 percent to 63 percent on the highest incomes. Furthermore, the corporate income tax was increased from 12 percent to l3 percent, and an exemption for small corporations eliminated; the estate tax was doubled, and the exemption floor halved; and the gift tax, which had been eliminated, was restored, and graduated up to 33 percent. (Sidney Ratner, American Taxation (New York: W.W. Norton, 1942), pp. 447-49).
Gold Standard
The USA Economy was offering a fixed price for Gold. This is known as the gold standard, where people can sell gold at a fixed price for dollars. The Federal Reserve had realized the value of gold was significant and they imposed this standard to obtain gold as a physical investment, this was also a reaction to the bank panics. The U.S was not the only one rushing to collect gold, other nations began to implement incentive such as higher interest rates to attract gold to their country. "Some economists believe that the Federal Reserve allowed or caused the huge declines in the American money supply partly to preserve the gold standard." (Britannica, 2014).
Interest rates in the USA were very low and investors which a large quantity of gold decided to store their gold in other countries who provided a better interest rate. That is when the war of interest rates began to attract gold. The gold standard standards issue was that it caused huge declines and restrictions in the money supply, leading to increased deflation which helped devalue goods and services, leading to a decline in prices and later, companies shutting down.
Stock Market Crash
The stock market crash of 1929 also fueled the depression, also it is argued that it had no direct affect to it because only 8% of households participated in the stock market at that time, the Fed's raise of bank rates to slow down the markets is where the real problem came.
Markets were roaring in the 20's, the new inventions and advances in technology indicated the economy was getting more productive as ever - at least that's what people thought as they ran into the stock market buying shares of the booming technology industry. What they really were doing was fuelling the bubble that was about to burst. These share prices were growing so rapidly and were in high demand from investors. "Markets were booming, with the shares of firms exploiting new technologies-radios, aluminum, and aero planes - particularly popular. But few of these new outfits had any record of dividend payments, and investors piled into their shares in the hope they would continue to increase in value." (Economist, 2014). Investors were moving away from businesses that already had been established and actually had proof of dividend payments with a good revenue track record became weaker, as people began to spend less. Startled by the soaring increase, the Fed chose to raise rates in 1928 to slow the markets, leaving the decision to cut them to help the overall economy in the trash.
This increase in rates had a shock on the whole stock market. stock were realized as being overpriced and being driven up to a price that didn't correlate with the company, the actual value was way less than the market had made it. This increase in rates did not just hurt Wall Street, but affected America's flagging industries, which had to cut production. "The Dow Jones index hitting a high of 381. But it hurt America's flagging industries. By late summer industrial production was falling at an annualized rate of 25%."
A sell off hit, the Dow Jones which had a high of 381 during the time, dropped 45% to two months. Black Tuesday as they call it, caused investors to lose $16 bln. "Over just two days, October 28th and 29th, the Dow lost 25%. By November 13th it was at 198, down 45% in two months." (Economist, 2014).
Theories
There are two popular opinions that I found related to my paper more, the keynesian theory and Hayek's theory. Keynesian's theory focused on the money supply while Hayek's theory went against Keynesian's and theorized around the banks, and the ease of obtaining loans.
One of the point of views as to why the depression occurred and how it can be solved was developed by John Maynard Keynes, a famous British Economist at the time and developed the Keynesian Theory. The Keynesian theory described why the depression occurred and what needed to be done to reverse it. His focus was primarily focused on consumer spending. Keynes describes that the economy dried up because people were not spending. Consumer spending being low was the cause of people not being paid enough or not employed. His solution to this was directed at government spending into industries such as construction, industrial and farming. He believed this spending will help the circulation of the money supply and lead people to begin spending, fuelling the economy through consumer spending. This increase in spending will help facilitate production which would then help increase demand overall, creating more jobs in the economy. "The cure for this, Keynes said, was for the central bank to expand the money supply. By putting more bills in people's hands, consumer confidence would return, people would spend, and the circular flow of money would be reestablished. Just that simple! Too simple, in fact, for the policy-makers of that time." (Huppi, 2014).
Frederich von Hayek's theory was also around consumer spending and around the banks. His view was that the over spending was an issue, contrary to Keynes theory. He discusses how the banks were loaning out money way too easily and the banking market was crowded full of lenders with no sense. There were no credit checks at that time, people could easily obtain a loan and they did. Everyone was using credit, from small purchases to large, they took out loans.
Two very opposite approaches. Keynes approach was to spend more, and Hayek believed it was better to sit back and do nothing. On the subject of causes, I believe Hayek has a more convincing and valid argument. Hayek's response to why the depression had occurred was the lending by banks and people using money they did not have. But his response on fixing it was a weak one. Overall, I feel that Keynes theory was more logical. To just sit and do nothing is not the way to recover huge losses, as suggested by Hayek. Keynes theory was a system that could have the possibility of working out. I believe the economy could be completely restored by more government spending where it is needed, such as the creation of jobs and injecting money into the economy would help industries get back on their feet by helping increase demand. How can people spend money when they don't have a job? The idea of putting money into the economy was the one that made the most sense to me as a solution. More government spending will mean more job creation, which means more household spending, meaning more demand, will mean production, meaning a healthy economy, as the strength of the economy is seen as how productive as a country is.