What caused the Great Depression?

The Wall Street crash of 1929 did not cause the Great Depression on its own. The damage came from waves of American bank failures that shrank the money supply, and from the gold standard, which passed falling prices from one country to the next.

Why the 1929 crash was not the cause

Through the 1920s many Americans bought shares with borrowed money, putting down a small part of the price. The Dow Jones average peaked at about 381 on 3 September 1929. When prices turned, the loans stayed the same size, so buyers sold to repay them and the selling drove prices lower. By 1932 shares had lost about 89% of their value.

Yet American output had already begun to shrink in August 1929, well ahead of Black Thursday and Black Tuesday in October. The crash made households unsure of their future pay, so they put off buying cars and furniture. It deepened a downturn that was already under way.

Why the banks failed and the money shrank

About 9,000 American banks shut between 1929 and 1933. A bank lends out most of its deposits, so even a sound one cannot repay everybody on the same day. Once a few banks closed, frightened customers emptied others, and the panic moved from town to town.

Savings locked in a closed bank cannot be spent, so the American money supply fell by roughly a third. Prices fell with it, while debts stayed fixed, which made every loan harder to repay. The runs stopped only after every bank was shut in March 1933 and the government began insuring deposits in 1934.

How the gold standard spread the slump

Every large economy had pledged to exchange its currency for a set weight of gold. Any country whose gold was draining away had to push interest rates up to hold on to the rest, which cut spending and pushed its own prices down. Countries gaining gold were under no matching duty to expand, so the fall travelled abroad.

Britain broke the promise in September 1931, and sixteen countries left or devalued that year. A cheaper pound let British goods sell abroad without wage cuts. America followed in 1933 and France held on until 1936. Recovery arrived in the same order: no country got better while it kept the gold link.

How the Depression ended

American unemployment, 3.2% in 1929, had reached 24.9% by 1933. Roosevelt's New Deal reopened the sound banks and later set up national pensions. Output grew fast from 1933, but in 1937 the Federal Reserve doubled the share of deposits banks had to hold back while a new payroll tax took money out of wages, and the economy shrank again from May 1937 to June 1938.

Full employment returned only with the Second World War. Building weapons and calling men into the forces used every spare factory and worker, and unemployment fell to 1.9% in 1943.