The causes of the Great Depression were numerous, and after the stock market crash of 1929, a number of complex factors helped to create the conditions necessary for the longest and deepest economic downturn in modern history.President Franklin D. Roosevelt’s decision to take the United States off the gold standard may have helped to ease the worst effects of theDepression.
What is the gold standard?
Sacks of gold, exchanged by the American people against currency, being stocked in the vaults of a New Jersey bank, 1933.
The gold standard is a monetary system in which a nation’s currency is pegged to the value of gold. In a gold standard system, a given amount of paper money can be converted into a fixed amount of gold. Countries on the gold standard can’t increase the amount of paper money in circulation without also increasing their reserves of gold.
From the late 1800s until the 1930s, most countries in the world—including the United States—adhered to an international gold standard. (Many European countries temporarily abandoned the gold standard during World War I so they could print more money to finance war efforts.)
Bank failures led ordinary citizens to hoard gold.
The U.S. economy boomed during the first part of the 1920s—the Roaring Twenties—with industries such as construction and automobiles driving the post-war recovery. In an effort to combat inflation, the Federal Reserve raised interest rates in 1928.
But European countries that had borrowed money from the United States during World War I had trouble paying off their debts. As a result, demand for U.S. exports slowed.
A slowing economy combined with the stock market crash of 1929 and a subsequent wave of bank failures in 1930 and 1931 led to crippling levels of deflation. Soon, the frightened public began hoarding gold.
European countries began to abandon the gold standard
The United States and other countries on the gold standard couldn’t increase their money supplies to stimulate the economy. Great Britain became the first to drop off the gold standard in 1931. Other countries soon followed.
But the United States didn’t abandon gold for another two years, deepening the pain of the Great Depression.
President Franklin D. Roosevelt as he signs the Gold Bill on his 52nd birthday, surrounded by members of the Treasury Department and the Federal Reserve Board.
FDR bans Americans from owning monetary gold
In 1933, President Roosevelt took the U.S. off the gold standard when he signed an executive order making it illegal for individuals and firms to possess most forms of monetary gold.
People were required to exchange their gold coins, gold bullion and gold certificates for paper money at a set price of $20.67 per ounce.
Abandoning the gold standard helped the economy grow
This exchange of gold for paper money allowed the United States to increase the number of gold reserves at the United States Bullion Depository at Fort Knox. After signing the 1934 Gold Reserve Act, Roosevelt raised the price of gold to $35 per ounce, allowing the Federal Reserve to increase the money supply. The Gold Reserve Act restored parts of the gold standard, allowing the dollar price to remain fixed until Richard Nixon fully abandoned it in 1971.
The economy slowly began to grow again, but it would take the United States most of the 1930s to fully recover from the depths of the Great Depression.
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Because the international gold standard linked interest rates and monetary policies among participating nations, the Fed's actions triggered recessions in nations around the globe. The Fed repeated this mistake when responding to the international financial crisis in the fall of 1931.
In addition, the gold standard, by forcing countries to deflate along with the United States, reduced the value of banks' collateral and made them more vulnerable to runs. As in the United States, banking panics and other financial market disruptions further depressed output and prices in a number of countries.
How did the Gold Standard contribute to the drop in the global economy? The paper money was given more value than it was worth. A piece of paper was worth 5 pieces of gold. This system caused a drop on the economy because more paper money was print than there was gold.
This article appeared in the Summer 2021 issue of The Independent Review. The cause of the Great Depression was the post-World War I decision to resume the gold standard on prewar terms, after immense inflation during the war.
The Government and Gold During The Great Depression
By law, the Federal Reserve was allowed to issue currency up to the point that it was 40 percent backed by gold. Therefore, as people redeemed their paper money for gold, it had a multiplier effect of reducing the amount of paper currency in circulation.
As its money stock automatically fell, aggregate demand fell. The result was not just deflation (a fall in prices) but also high unemployment. In other words, the deficit country could be pushed into a recession or depression by the gold standard. A related problem was one of instability.
The Gold Reserve Act of 1934 was passed under President Franklin D. Roosevelt at the height of the Great Depression to stabilize the money supply in the U.S. Gold reserves were transferred from the Federal Reserve bank to the U.S. Treasury at a discount.
What were the major causes of the Great Depression? Among the suggested causes of the Great Depression are: the stock market crash of 1929; the collapse of world trade due to the Smoot-Hawley Tariff; government policies; bank failures and panics; and the collapse of the money supply.
The Causes of the Great Depression Overproduction: The 1920s witnessed a rapid economic expansion, as manufacturers made and sold new products like cars, radios, and refrigerators. Many consumers lacked the money to buy these goods. Manufacturers were soon producing more goods than they could sell.
The beginning ofAmerica's "Great Depression" is often cited as the dramatic crash of the stock market on "Black Thursday," October 24, 1929 when 16 million shares of stock were quickly sold by panicking investors who had lost faith in the American economy.
Stock market crash of 1929. The failure of banks, which was the impact of the stock market crash as more people withdrew their savings from the banks leading to closure. Reduction in purchases due to diminished savings.
Final answer: The trend of buying consumer items on credit contributed to the Great Depression by leading to a rise in consumer demand initially, but ultimately causing drops in profits and employment due to defaults on credit payments and underconsumption.
Because the international gold standard linked interest rates and monetary policies among participating nations, the Fed's actions triggered recessions in nations around the globe. The Fed repeated this mistake when responding to the international financial crisis in the fall of 1931.
On April 20, President Roosevelt issued a proclamation that formally suspended the gold standard. The proclamation prohibited exports of gold and prohibited the Treasury and financial institutions from converting currency and deposits into gold coins and ingots.
Mobilizing the economy for world war finally cured the depression. Millions of men and women joined the armed forces, and even larger numbers went to work in well-paying defense jobs. World War Two affected the world and the United States profoundly; it continues to influence us even today.
Because the supply of money (gold) essentially was fixed in the short run, U.S. prices fell. Prices of U.S. exports then fell relative to the prices of imports. This caused the British to demand more U.S. exports and Americans to demand fewer imports.
Millions of Americans used credit to buy all sorts of things, like radios, refrigerators, washing machines, and cars. The banks even used credit to buy stocks in the stock market. This meant that everyone used credit, and no one had enough money to pay back all their loans, not even the banks.
Among the suggested causes of the Great Depression are: the stock market crash of 1929; the collapse of world trade due to the Smoot-Hawley Tariff; government policies; bank failures and panics; and the collapse of the money supply.
The Great Depression was global and had many causes. However, policy errors in the United States and abroad played an important role. The Federal Reserve failed in both parts of its mission. It did not use monetary policy to prevent deflation and the collapse of output and employment.
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