Causes of the Great Depression - Sample Economic Analysis Term Paper

This example economics term paper analyzes the culture of speculation during the 1920s, and argues how it contributed to the severity of the Great Depression. Using descriptive body paragraphs that tell how stock traders like Jessie Livermore were superstars and housing prices were on the rise, this sample essay portrays how the speculative party abruptly came to an end. It employs block quotes and vivid examples to make its body paragraphs stand out. It would be a great reference for a student who wants to write about economic history and successfully use background evidence for maximum effect.

Capital gains, national losses: An examination of speculation in the 1920s

When the guns of World War I fell silent, the United States emerged relatively unscathed. While Europe lay broken, America celebrated a new age of prosperity. But unfortunately the party would be short lived. This paper examines how the speculative culture of the 1920s - which could be found in the stock market, housing construction and consumer spending habits - set the stage for the Great Depression.

The 1920s, often referred to as the Roaring 20s, brought new changes to America. As families grew richer, they could afford items once considered luxuries. Automobiles were a prime example. Encarta Encyclopedia's "Roaring 20s" article says, "Annual car sales tripled from 1916 to 1929" and that "9 million motorized vehicles on the road became 27 million by the end of the 1920s" (25). The 1920s also introduced new technology designed to make life easier for the American consumer. Factories churned out "new home appliances such as refrigerators, washing machines, and vacuum cleaners" (25). With so much consumer demand, it was a good decade to be in business. Economist John Kenneth Galbraith explains in his book The Great Crash of 1929 how "American capitalism was undoubtedly in a lively phase. Between 1925 and 1929, the number of manufacturing establishments increased from 183,900 to 206,700 [and] the value of their output rose from $60.8 billion to $68.0 billion" (Galbraith 2). Finally, Americans themselves adopted a consumerist attitude. This new attitude was illustrated by Flapper girls, women armed with "bobbed hairdos, short skirts, makeup, and cigarettes" who supported growth industries of the 1920s like "the beauty parlor, the ready-made clothing industry . . . and tobacco production" (Encarta 26). The overall mood of the 1920s caused President Calvin Coolidge to tell Americans they should "regard the present with satisfaction and anticipate the future with optimism" (Galbraith 1).

But while Coolidge praised Americans at the time, "they were also displaying an inordinate desire to get rich quickly with a minimum of physical effort" (Galbraith 3). Those who wanted to become wealthy engaged in speculation, which lecture describes as an investment activity which involves predicting future price movements. There is a difference between speculative investment and regular investment. John Maynard Keynes in his General Theory of Employment, Interest and Money clarified this difference: Speculation is the "the activity of forecasting the psychology of the market" while long-term investment, which Keynes calls "enterprise" is the "activity of forecasting the prospective yield of assets over their whole life" (Keynes 6). Thus, speculators invest their money in the short term, with the hope that they will make a profit when prices rise. Keynes observed that enterprise normally outweighs speculative investment, but in New York "the influence of speculation. . . is enormous" (Keynes 6). The British economist worried that the American propensity for speculation was dangerous. Unlike the English who invest for income, Keynes felt American investors were "attaching [their] hopes, not so much to [a security's] prospective yield, as to a favourable change in the conventional basis of valuation" (Keynes 6). Keynes concluded that the typical American investor was "in the above sense, a speculator" (Keynes 6). He warned that "when the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done" (Keynes 6).

Jesse Livermore was perhaps the most famous stock market speculator of the 1920s. According to the PBS documentary, The Crash of 1929, Livermore "didn't study the health of a company. He didn't care whether it made a profit or paid a dividend. For him, the stock market was an abstract game of numbers." Livermore was reportedly worth over $100 million at one point in his life. His daughter in law, Patricia, explained in the documentary that the Livermores had four houses as well as "private railroad cars" and "two yachts." "They really lived," Patricia Livermore said. Livermore was a notoriously private man, but shortly before the end of his life he described how speculators approach the market. In his article "When does a stock act right?" Livermore said:

A speculator of great genius once told me: "When I see a danger signal handed to me, I don't argue with it. I get out! A few days later, if everything looks all right, I can always go back in again. Thereby I have saved myself a lot of worry and money. I figure it out this way, if I were walking along a railroad track and saw an express train coming at me at sixty miles an hour, I would not be a damned fool enough not to get off the track and let the train go by. After it had passed, I could always get back on the train again, if I desired." (Livermore 98).

Speculators would often try and time the market, selling before they thought it would go down, and buying before it looked like it would rise. Livermore noted that many speculators could not master this technique. "Curiously, the trouble with most speculators is that something inside of them keeps them from mustering enough courage to close out their commitment when they should. They hesitate and during that period of hesitation they watch the market go many points against them," he said (Livermore 98). Despite his success, Livermore warned those with little experience to stay away from constant investing. "One cannot be successful by speculating every day or every week" (Livermore 99) he said. Despite this advice, many people were only interested in earning excessive returns. Robert Sobel, a historian in the documentary said the "average American would look at [Livermore's success] and say, 'Gee, if only I knew what he was doing, I could make money, too. How do you get in on Jesse Livermore's brains?'"

Stock speculators like Jesse Livermore used a variety of techniques to earn money. One method, as described by the PBS documentary involved wealthy investors pooling their money together "in a secret agreement to buy a stock, inflate its price and then sell it to an unsuspecting public." In 1929, Michael Meehan, the head of a brokerage firm created a pool to push up the value of RCA's stock by almost 50 percent. In one week, the pool "sold and divided up their profits. In today's money, they had made $100 million for one week's work." Those in the pool would often work with the financial press to help market the rising stock. Sobel explained in the documentary how the alliance between the rich and the press would trick normal people into joining the scheme:

You want to join them, so you go out and you buy stock also. Now, what's happening is the stock goes from 10 to 15 to 20 and now, it's at 20 and you start buying, other people start buying at 30, 40. The original group, the pool, they've stopped buying. They're selling you the stock. It's now 50 and they're out of it. And what happens, of course, is the stock collapses (PBS). By "painting the tape," as this type of manipulation was called, wealthy investors could benefit from gullible, working-class speculators.

In addition to pooling money, speculators also bought stocks with borrowed funds. This tactic, known as margin buying, allowed investors to multiply their returns without spending a lot of their own money. For example, if one wanted to buy $10,000 worth of stock, and the margin rate was 10 percent, they would only have to put down $1,000 while the rest is borrowed from their broker. As long as the stock price continued to go up, margin borrowers were fine. Professor Harold Bierman of Cornell University explained that while rates were typically higher than 10 percent, "at the end of October [1929], margins were lowered to 25%" (Bierman 7). In contrast, potential margin buyers today are required to put up 50 percent of their own money. Buying on margin was especially useful for small-time investors, including Groucho Marx, the famous comedian. The documentary explained how Marx, like many people, would "rush to his broker to put more of his savings into the booming market, on margin, of course." But margin buying had its disadvantages as well. If a stock price dived, investors faced a margin call. Here, the broker would tell their client that the amount of money they had in a stock had dropped below their down payment and would need to put up more cash if they wanted to continue holding the security. If the client could not put up the money, the broker would sell the stock and the client would take a loss. Margin calls, as Bierman explains "probably exacerbated the price declines" (Bierman 7) when people started selling stocks in a panic.

Most scholars believe the stock market crash of 1929 cannot be linked to a single cause. However, what can be certain is that it wiped out the fortunes of many Americans. The stock market's biggest supporters in the banking community were among the hardest hit. The documentary explains how Tom Lamont, acting head of J.P. Morgan bank met with other bankers to try and stem the panic. The bankers' pool put up a substantial sum of money to make credit easier for margin buyers. Unfortunately this was not enough. The documentary noted that everyone wanted to sell and major stocks plunged. AT&T fell 50 percent. Shares of "RCA, once $110 a share, couldn't find buyers at $26. Blue Ridge [once at $100] plunged to $3 and still no buyers. On the floor, they had never seen anything like it." Wealthy men like William Durant, the founder of General Motors, lost everything - his only assets were his clothes. After Black Thursday, October 24th, ordinary investors, "the tailors, the grocers, the secretaries -- stared at the moving ticker in numb silence," as "hope of an easy retirement, the new home, their children's education," vanished with the falling market.

Although the stock market crash may not have caused the Great Depression, it certainly contributed to a severe dip in consumer confidence. Christina Romer wrote that "the stock market crash reduced American aggregate demand substantially" because "consumer purchases of durable goods and business investment fell sharply after the crash" (Romer 3). Romer goes on to say that "although the loss of wealth caused by the decline in stock prices was relatively small, the crash may also have depressed spending by making people feel poorer" (Romer 3). The speculative party had come to an end.

Despite the stock market's popularity, it was not the only form of speculative excess that was in vogue during the 1920s. Speculators also chased high returns in the housing market. John Kenneth Galbraith elaborated on housing speculation in Florida. Relatively undeveloped at the time, Florida seemed like a gold mine for housing speculators. During this period, people thought that "the time indeed was coming when the annual flight to the South would be as regular and impressive as the migrations of the Canada Goose" (Galbraith 3). Despite Florida's temperamental climate, people "wanted to believe that the whole peninsula would soon be populated by the holiday-makers and the sun-worshippers of a new and remarkably indolent era. So great would be the crush that beaches, bogs, swamps, and common scrubland would all have value" (Galbraith 3-4). But those who ended up buying the land were not homeowners, but other speculators, who hoped to turn around and sell it for a profit. Galbraith notes that "much of the unlovely terrain that thus changed hands was as repugnant to the people who bought it as to the passer-by" (Galbraith 4). The buyers did not expect to live on the land itself, because after all, "this dubious asset was gaining in value by the day and could be sold at a handsome profit in a fortnight" (Galbraith 4). The speculators used clever marketing schemes to lure in buyers. The land was divided into building lots, which were increasingly further away from cities. In one example, a developer sold land "near Jacksonville" when the subdivision was really sixty-five miles west of the city (Galbraith 4). In some cases, lots were billed as close to prosperous and fast-growing cities, but these cities actually did not exist (Galbraith 5). Even professional orators like William Jennings Bryan were brought in to hawk the benefits of Florida real estate (Galbraith 5). But the Florida housing bubble soon burst. The arrival of a tropical storm in 1926 which "killed four hundred people, tore the roofs from thousands of houses and piled tons of water and a number of elegant yachts into the streets of Miami" (Galbraith 6) dashed the hopes and fortunes of speculators in the Sunshine State.

The Florida speculators became the laughingstock of America - the PBS documentary showed footage from the Marx Brothers' 1929 film The Cocoanuts in which gullible people are lured into buying worthless real estate. But land speculation was no laughing matter as it helped worsen the Depression. Alexander James Field's article, "Uncontrolled Land Development and the Duration of the Depression in the United States," addresses the nation's obsession with overbuilding. Field explains that "residential construction alone exceeded 8 percent of GNP in each of the four years from 1924 to 1927" and that infrastructural investment "dominated net capital formation, even more so than it has in other peacetime expansions" (Field 785). Field points out that Florida was not the only state to experience a housing boom. The area around Detroit, Michigan experienced a burst in housing construction with the arrival of the automobile. Because more people were buying cars, builders assumed they would be willing to travel further. Thus, "in the area surrounding Motor City, the potential impact of the automobile on suburban development had been so enthusiastically embraced that subdivided land extended to Pontiac and Flint, Michigan, 20 to 50 miles from downtown" (Field 791). As more cars entered the roadways and electricity spread to suburban areas, "fortunes could be made simply from the subdivision, sale, and resale of land, particularly at the city's edge" (Field 792). But the building honeymoon would soon end. When the Depression hit, many of these Detroit lots were vacated. "More than 95 percent of recorded lots in four townships in suburban Detroit were vacant in 1938," Field said (791). This statistic is jarring because "20 to 30 million vacant lots of record nationally is brought into perspective when it is compared with the 1930 housing stock, which contained approximately 30 million occupied housing units" (Field 791).

When housing construction virtually halted in the 1930s, the nation's output was severely affected because housing was the largest portion of GDP investment spending. Field writes, "Real spending on new private nonfarm housing fell 89 percent from its peak in 1926 to the trough in 1933; over the same period total real spending on new construction fell 71 percent" (785). He argues that the Depression was so severe because the housing market took years to recover. Indeed, lecture explains that the housing market would not return to normal levels until World War II. "Although the technology of building profitable neighborhoods through coordinated, large-scale development was widely understood by the late 1930s," recovery was hindered by "encumbrances on locationally choice acreage" (Field 788). These encumbrances included legal and transaction costs plus the decision of whether the new builders should demolish the existing buildings or restore them (Field 788). In addition, it was often difficult to track down who owned the land. During the 1920s, housing lots were often owned by multiple individuals. This fractional ownership meant that "one overreaching individual could effectively block reassembly by holding out for a larger share of the developer's anticipated profit" (789). It could be argued that speculators in the housing market fared much worse than those in the stock market. Indeed, "many owners of record had simply walked away from their tax (and mortgage) obligations in a declining land market" (Field 789) forcing the banks to absorb the costs of their mistakes instead.

The housing boom was taken as a sign that "God intended the American middle class to be rich" (Galbraith 4). Normal consumers, enraptured by the success of men like Jesse Livermore, also got caught up in the national spending spree. The PBS documentary explains that "One of the most wondrous inventions of the age was consumer credit. Before 1920, the average worker couldn't borrow money." Indeed, Martha Olney in Avoiding Default: The Role of Credit in the Consumption Collapse of 1930 says "before the 1920s, prudent families would not borrow to buy consumer goods; those families that did buy on installments apparently did so with a sense of shame" (Olney 327). However, as the documentary notes, "by 1929, 'buy now, pay later' had become a way of life." Buy now, pay later was the marketing tactic attached to installment plans, a new form of payment in the 1920s. In these plans, families would pay for an item in small payments, or installments, over a period of time. The plans became more attractive as household wealth grew in the 1920s. "Over 41 percent of the 506 federal employees whom the BLS surveyed in 1928 bought a good on installments," (323) Olney writes. The plans were useful for those who wanted to keep up with the Joneses (or Livermores) - they could have a new car without paying the full price up front. Indeed, cars were the most popular installment item. Indeed, "throughout the interwar years, 60 to 70 percent of cars were purchased on installments" (323). In 1929, nearly one quarter of families bought a car (323), which symbolized the new American mobility.

Despite their new goods, consumers had to abide by strict terms when they signed installment plans. Olney said that "legal ownership of the good being purchased on installments did not transfer until the contract was completed" (321-322). In addition, the seller "reserved the legal right to repossess 'their' good if payments were late" (Olney 322). Consumers were also unable to recover the surplus, the difference between their installment payment and the original price of the product. Finally, households could not resell these items in the middle of their installment contract, which meant they "could not liquidate their durable goods to avoid default" (Olney 322). Thus, if a family bought a 1929 Ford Model A, they were more likely to maintain their installment payments so the car would not be repossessed. Making regular payments was crucial, especially since the plans often took up a significant portion of a family's disposable income. "Auto prices were 20 to 60 percent of average annual disposable income, pianos cost about one-third of disposable income, and refrigerators and stoves were 5 to 10 percent of disposable income," (322) Olney writes. Maintaining a wealthier lifestyle was costly, but worth it to these families.

Unfortunately, because it was expensive for families to default, they chose to reduce their consumption instead, which hurt the economy overall. Unwilling to give up their cars or refrigerators, households kept up with their payments. "Well below 1 percent of auto contracts held by CCC in 1930 were 60 days or more past due, a lower percentage than had been past due in 1925, 1926 or 1927. Refinancing existing contracts also appears to have been uncommon in 1930," (326) Olney said. Instead of default, families with burdensome contracts had few choices:

Selling the good and using the proceeds to pay off the contract was ruled out by most installment contracts. Liquidating other assets would have been difficult both because aggregate saving rates had fallen and because installment debt was used most often by young households who had little or no accumulated savings. [Also] increasing the family's wage income was problematic because aggregate employment was declining, hours were falling [and] wages were being cut (328). The only thing families could do to earn more money on the side was to sell groceries or clothes - which provided relatively little money - or to reduce consumption of other goods so they would have more money to make the payments. After the stock market crash in October 1929, families faced greater income uncertainty, but did not change their debt payments "because default would have triggered wealth-reducing repossession" (Olney 333). As a result, "families reduced consumption in nearly all spending categories" (Olney 333).

For a typical American family burdened with debt but not willing to hand over the car keys they had worked for, reducing their consumption of food and other goods was the best policy. But when millions of families followed this debt-avoidance pattern, the nation's consumption declined precipitously. Olney estimated that if "25 percent of families were using installment credit, their fear of a wage cut will lead to a fall in aggregate consumption of 3.0 percent" (333). Their spending cuts were across the board: "Food and tobacco spending fell in real terms by 2.2 percent" while personal business declines, "transportation, household operation, clothing and food together accounted for nearly 97 percent of the change in total consumption expenditure" (Olney 329). Ironically, when default became less expensive during the 1938 recession, consumption did not decline as severely. But at the start of the Depression, the consumption decline rattled the nation. As Christina Romer said, "between the peak and the trough of the recession, industrial production in the United States declined 47 percent and real GDP fell 30 percent" (Romer 1). In contrast, GDP only declined 2 percent during the recession of 1981-82. For families, a life of luxury now seemed out of reach.

Few could avoid being caught up in the splendor of the 1920s, as money could be made with borrowed cash and luxury items could be bought on credit. But the speculative excess contributed to the dismal era of the 1930s - for the first time America saw bread lines and unemployment at 25 percent. But are America's speculative booms and busts inevitable? Galbraith thinks so: "The United States is afflicted with new eras. Let us not think for a moment that the illusion, the aberration of the 1920s was unique. It is intimately a part of the American character," he says on the PBS documentary. But despite his words, perhaps a closer study of history could do Americans some good if they want to avoid another Great Depression.

Works Cited