What Factors Contributed to the Collapse of the US Economy at the End of the 1920s?

by Ralph Heibutzki
By 1932, stocks lost 90 percent of their original value.

For many historians, the stock market crash of October 1929 remains the defining image of economic crisis. The crash is commonly seen as the kickoff for the Great Depression, which idled about 25 percent of all Americans, and left an additional 50 percent underemployed, according to Notre Dame University. However, both events also exposed the weaknesses of America's banking system, lending practices and monetary policies -- which also played major parts in the economy's collapse.

Extreme Wealth Inequity

Record economic growth also coincided with widening gaps in wealth and corporate power. For example, the top 1 percent of Americans earned 650 percent more than the bottom 11 percent, according to the University of Notre Dame. By 1929, a wave of mergers and consolidations meant that 200 companies controlled half the nation's corporate wealth. As a result, the economy became too dependent on high levels of investment and luxury spending -- which magnified the effects of its collapse once these activities cooled off or companies went bankrupt.

Flawed Banking Systems

The economic meltdown of the late 1920s also doomed many smaller local banks. Branch banking didn't exist, so most institutions served the immediate local market, notes David Wheelock, an economist for the Federal Reserve Bank of St. Louis. However, banks didn't guarantee deposits, triggering "runs" that increased the risk of their collapse. For example, 744 banks failed during the first 10 months of 1930 alone, states Penn State University's article, "Causes of the Great Depression." The United States economy lost billions of dollars in assets, leaving many communities with nowhere to turn when their local banks failed.

International Trade Breakdown

The U.S. economy's collapse accompanied an equally severe contraction of global trade. These issues arose when European nations sought forgiveness for World War I-era debts, Penn State's article indicates. Instead, the country's banks only extended credit to pay existing debts. For example, the German government relied on private American and British loans to make war reparation payments. However, such loans became harder to get after the stock market crash. High trade barriers also made it difficult or impossible to sell products in Unites States markets, which caused many European nations' economies to falter.

Tight Money Policies

Perceptions that stock prices were too high prompted the Federal Reserve Board to sharply raise interest rates, especially for those charged on broker loans, Notre Dame's analysis shows. However, this approach led to a severe contraction of the money supply. A sharp decline in output and income followed, and caused the country's economy to shrink even further. Lack of confidence in the banking system, as well as a widespread reluctance to buy goods, complicated efforts to get the economy going again. As Wheelock notes, these problems only eased after 1934, when the Federal Reserve moved aggressively to increase the money supply.

About the Author

Ralph Heibutzki's articles have appeared in the "All Music Guide," "Goldmine," "Guitar Player" and "Vintage Guitar." He is also the author of "Unfinished Business: The Life & Times Of Danny Gatton," and holds a journalism degree from Michigan State University.

Photo Credits

  • Jupiterimages/Photos.com/Getty Images