Depression, Great

The Gold Standard

The most important of the long-term causes was the restoration of the international gold standard in the years after World War I. The gold standard presupposed a free flow of gold, which would inflate the prices in the country that attracted it and deflate them in the country that lost gold. In due course, a reverse movement would set in, which would restore the international equilibrium. After the war, the United States experienced a massive inflow of gold, but its Federal Reserve Bank (FED) maintained price stability by sterilizing gold and issuing Reserve Bank credit. When Great Britain returned to the gold standard at the prewar parity, the FED supported this by providing ample credit worldwide. This also fueled a boom in the United States, which then led to a wave of stock market speculation that ended in the crash of October 1929.

Speculators could borrow money from the banks to buy stock and use it as collateral for further bank credits. The increasing demand for stocks led to the creation of holding companies, which did not produce anything but only owned other companies. A house of cards was built in this way. In 1925, total new investment amounted to US$3.5 billion and to US$3.2 billion in 1929, the nominal value of shares increased from US$27 to US$87 billion in this period. The FED wanted to stop this development by raising interest rates, but the speculators were not deterred by this as they expected higher returns from the stock market. It [Page 389]took some time before credit contraction put the brakes on speculation, and, when the crash came, the FED did not rush to provide credit. The crash by itself would not have caused the depression. The crash of 1987 was much more dramatic, but it did not cause a depression. However, in 1929, the U.S. economy was more fragile. Sales of cars and durable consumer goods dropped immediately after the crash. Even more alarming was the drop of the wheat price, which released an avalanche of wheat inundating the world market.

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