This blog post examines how the 1929 collapse of the U.S. stock market spread into a global economic depression.
The Great Depression that struck the entire world in the 1930s was an economic downturn of unprecedented severity and duration in the history of capitalism. The scale and duration of the economic shock were unparalleled compared to any previous recession, causing massive societal impacts such as countless businesses closing and tens of millions becoming unemployed. The epicenter of the Great Depression was none other than the United States. The massive stock market crash in New York at the end of 1929 is recorded as the symbolic event heralding the onset of this catastrophe. What exactly was wrong with American society and its economy at the time? What structural flaws led to such devastating consequences?
In the late 1920s, American society was, on the surface, enjoying dazzling economic prosperity. New industries like electricity, automobiles, and home appliances emerged, boosting productivity and living standards, while mass consumption culture rapidly spread. People harbored optimistic expectations amid unprecedented prosperity and sought to experience that prosperity through consumption. However, this prosperity was merely superficial. Looking deeper into the economy revealed that serious structural imbalances had been accumulating. The most significant problem was the inequality of income and assets. Wealth was concentrating at the top, causing the actual purchasing power of the middle and lower classes to gradually shrink. Production was increasing, but there were fewer consumers to buy it.
The core industry driving the growth of the U.S. economy at the time was the durable consumer goods sector. Among these, the automobile industry was considered a prime growth engine. By 1928, on average, one in six Americans owned a car, meaning most households in the middle class and above had purchased a vehicle. Considering the imbalance in income distribution, this figure suggests car ownership had reached a remarkably high level. In other words, the automobile market was already approaching saturation, and the potential for creating new demand was gradually reaching its limits.
Housing construction had also been a driver of economic growth for some time, but it too reached saturation over time. The wealthy in the United States already owned spacious, comfortable homes, and as the middle class also attained a certain standard of housing, new demand for homes declined. In other words, major household consumption had already reached saturation, and the domestic market that could absorb the products manufactured by companies began to shrink. In this situation, capital flowed in search of new investment opportunities, and that money naturally poured into the stock market.
The early stock market, coupled with optimistic economic outlooks, offered relatively stable returns, attracting more investors. However, over time, simple ‘investment’ gradually degenerated into ‘speculation’. Not only the upper class, but also the middle class, and even low-income farmers began jumping into stock investment, with many securing investment funds through bank loans. The belief that stocks would continue to rise spread throughout society, and the ‘bubble’ rapidly inflated.
Banks actively joined in. Loans secured against stocks purchased by customers became commonplace, and financial institutions’ risk management standards gradually loosened. While this structure posed no problem when stock prices rose, it was a dangerous model: if prices fell below a certain level, the value of the collateral plummeted, making loan recovery difficult. Ultimately, the stock market could no longer sustain the bubble and collapsed, instantly pushing countless investors toward bankruptcy.
The problem did not end there. As the financial system crumbled and the stock market collapsed, the role of the central bank, the Federal Reserve Board (FRB), was more critical than ever. However, the FRB’s monetary policy at the time acted to worsen the crisis rather than calm the situation. Theoretically, the FRB could adjust the discount rate and control the money supply to curb economic overheating or mitigate recessions, but in practice, it failed to implement such measures effectively.
The directors of the regional central banks under the FRB were predominantly drawn from private banks. They tended to possess more conservative commercial banking perspectives than professional expertise in financial policy. Consequently, they leaned toward risk aversion and monetary tightening rather than proactive monetary policy responsive to business cycles. Indeed, the FRB attempted to curb bank lending by raising the discount rate during the stock market boom, but the increase in interest rates had only a negligible effect compared to the high returns achievable through stock investments.
The problem arose after the stock market collapsed. When faced with such a massive economic shock, the appropriate response for a central bank should have been rapid and aggressive monetary expansion—that is, injecting liquidity into the market to ease economic rigidities. However, the Federal Reserve Board (FRB) chose the opposite path. By maintaining a tightening policy of reducing money supply and raising interest rates, it triggered deflation. This led to a rise in real interest rates, severely dampening corporate investment sentiment. This vicious cycle accelerated the collapse of the entire U.S. economy, transforming a simple financial crisis into a full-blown Great Depression.
Meanwhile, the fragility of the international financial order was a decisive factor in the spread of this domestic U.S. situation worldwide. The international gold standard, suspended during World War I, was restored after the war, but its foundation had already weakened, and its institutional stability remained unresolved.
Traditionally, Britain had been at the center of the international credit system, but after the war, the United States took its place. The U.S. emerged as the world’s largest creditor nation, becoming the central axis of international financial markets. It recorded massive international balance of payments surpluses from receiving principal repayments and interest on capital lent during the war. Additionally, the U.S. maintained protectionist policies, increasing its exports of goods and sustaining a trade surplus.
The problem was that debtor nations needed to earn foreign currency through exports to repay their debts to the United States, but high U.S. tariffs and protectionism made exporting difficult. This made debt repayment even harder, and the world’s gold increasingly flowed only to the United States. If the United States had used this inflow of gold to expand its domestic money supply and act as a global liquidity provider, the situation might have improved somewhat.
However, the U.S. government and the Federal Reserve adhered to a stance of strictly suppressing inflation. Consequently, the gold flowing into the U.S. was not converted into currency but was effectively locked up under a kind of ‘burned gold’ policy. The core principle of the international gold standard was that gold inflows should lead directly to currency expansion and inflation, but the U.S. did not follow this principle.
Traditionally, the gold standard was believed to possess a self-balancing, self-regulating mechanism. In reality, however, stable operation required a powerful financial institution acting as the lender of last resort. The Bank of England had previously fulfilled this role to some extent, but the Federal Reserve prioritized domestic price stability above all else, showing indifference toward international financial stability.
Consequently, had the United States adopted a more open and responsible financial policy during the 1920s, and especially during the critically important period from 1929 to 1933, the impact of the Great Depression could have been mitigated. However, this was not the case. A complex interplay of policy failures, structural flaws, and instability in the international order plunged the global economy into deep darkness.
Thus, the Great Depression was not merely a stock market crash, but a comprehensive catastrophe caused by complex domestic and international economic structures and the misjudgments of policymakers. Consequently, the capitalist system was forced to undergo fundamental reflection, leading to a major turning point in subsequent economic management and policy direction.
