Term Paper: How Income Inequality Led to the Great Depression

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Income Inequality and the Great Depression

In a recent interview, presidential political advisor David Axelrod stated that President Obama "inherited the worst recession since the Great Depression…." (Jackson, 2012) in terms of American history, the Great Depression looms over the U.S. like some sort of mythological ogre, albeit an economic one, and this ogre frightens politicians and the public alike. Everyone has heard stories of brokers and bankers jumping out of windows to their deaths, of families forced to leave their homes to become migrant workers, and of people hiding money in their mattresses because they did not trust the banks. The Great Depression was a national trauma that has had long-lasting effects on the nation. Economists, historians, and others have debated the causes of the Great Depression ever since it happened, with a number of theories, some extremely complicated and intricate, to explain the worst economic collapse in the history of the world. But the theory from which all others seem to sprout for the Great Depression is a rather simple one: economic inequality. Whether one blames micro and macroeconomic forces such as aggregate demand, instability of wages, banking panics, or others, the truth is that all of these can trace their roots back to the fact that too much wealth was accumulated in the hands of too few people who did not use it for the benefit of the national economy but for their own selfish gains.

The Great Depression is said to have begun with the stock market's "Great Crash" on October 29, 1929, but events had been heading toward such an event for some time. After almost seven years of rising stock prices, in September of 1929 they began to slip downwards. While most believed it was just an economic hiccup, by October the hiccup had become a downward slide in stock prices. October 19th saw a "sudden wave of selling…," and by Thursday, October 24, a wave of panic selling erupted. (Downing, 2001, p.4) There was an attempt to stabilize the situation over the weekend, but by Tuesday, known as "Black Tuesday," the market had crashed. In the three years immediately following the crash, American "real GDP fell by about 25%, and nominal GDP by about 50%…," with the unemployment rate peaking at just about 25%. (Hall, 1998, p.4) There was some recuperation of the economy in the years from 1934-1937, but by 1937 "output fell again, and the Great Depression was considerably prolonged in the United States." (Hall, 1998, p.4) Ultimately the Great Depression, which actually consisted of two separate recessions, kept economic output in the United States below average for more than 12 years.

The Great Depression actually had its roots in the 1920's; a period that saw a tremendous expansion in the American economy and the rise of the businessman. As Robert McElvaine stated in his widely popular book, the Great Depression: America 1929-1941, "The twenties cannot be comprehended without understanding that after two decades of reform sentiment, businessmen were once again in the saddle." (McElvaine, 2009) and while at this time there was an attempt at what became known as "corporate welfare" in which corporations provided workers with a number of extravagant benefits, the collapse of the stock market in 1929 led to the collapse of such programs. In the early 1920's, however, business was the "silver bullet" that was to lead America into a new era of prosperity. But the boom in business in the 1920's was the result of the Great War, or World War I, and the "vast series of shifts in the fundamental conditions of demand and supply…" (Robbins, 2007, p. 3) in the years during and immediately following the war, the global economy was unable to adapt to the new conditions that had developed, most particularly the using up of capital and the lowering of productivity in the industrial sector which both led to the inability of the global economic system to adapt. But these indicators were not recognized by the general population and in the United States, for example, there seemed to be an economic boom occurring.

The economic boom of the 1920's was not a boom at all but a bubble created by the extension of credit, and as time went on, credit became over extended. This credit, mostly provided by institutions other than banks, such as brokerage firms, mortgage companies, etc., could not expand continually, and it has been argued that the "depression only began when credit expansion ceased." (Rothbard, 2008, p.23) the government could not back credit expansion continually because of two main problems: firstly, the longer the credit boom continued, the more economically serious and painful the consequences, and, the boom could not continue indefinitely because the public ultimately lost confidence in the economy. This is exactly what happened when the stock market crashed in 1929, the credit bubble burst, deflation occurred, and with it came the subsequent economic calamities.

But these calamities can be argued were the result of a contraction in the amount of money in the economy. While some may blame it on overproduction, and others on under-consumption, the result was that there was too many items being produced and not enough money for people to purchase them. But what happened to all the money? Firstly, as business continued to expand during the twenties, more and more of those with means did not use their money to invest in new businesses, they left it to those extending credit to do so. Instead of investment in the economy, the wealthy in American began to put their money in savings. According the Keynesian theory of economics, savings and investments are "indissolubly linked," with savings removing monetary resources from the general economy. (Rothbard, 2008, p.38) the increased availability of credit led to an increase in savings, or the hoarding of money by the wealthy, and when the credit bubble burst, there was no money available to continue the good times.

Within these economic explanations of the Great Depression lies the concept of income distribution. It is almost universally accepted that the increase in credit, tied to the decrease in actual money in the economy, led to a situation where, when the credit bubble burst there was not enough cash in the system to keep the system going. This problem is intricately linked to the problem that the country had with income distribution. "The distribution-of-income problem refers to the fact that while most people were becoming better off, those at the top of the income scale were becoming relatively much more affluent that those in the lower income bracket." (Hall, 1998, p.21) it has been estimated that the total income accrued by the top 1% of income earners rose from 12% in 1922 to close to 14% in 1929. And in that same time, the percentage of the total wealth held by the top 1% rose from 32% to almost 40%. But the most devastating statistic that has been demonstrated is the fact that in 1922 the top 1% of the population accounted for about 50% of all savings, but by 1929, that figure had risen to more than 80%. In other words, the top 1% of the economic scale in the United States had accumulated more and more wealth during the 1920's, and they did not invest this wealth back into the economy, they were hoarded it.

Another indication that the wealth in the United States was being accumulated in the hands of fewer and fewer people is the fact that worker's wages grew at a slower rate than worker output. This means that workers were producing more while their wages were not rising as fast as their output. The result of this situation was an increase in corporate profits, as indicated in the amount of dividend paid to investors during this time. In 1920, dividends constituted only a little more than 4% of the national income, however, by 1929, that figure had risen to over 7%. And since the majority of dividends were paid to those within the top 5% of the economic bracket, the wealthy continued to get wealthier; adding to the great imbalance in the distribution of income. Many economists and historians point to the argument that as more wealth is accumulated in the hands of fewer, high income individuals, "the average aggregate propensity to consume falls." (Hall, 1998, p.22) as workers produced more, they received proportionately less and were unable to continue consuming as they had in the past; while the wealthy received more but because there were simply too few wealthy people to consume all the products, consumption decreased. This led to a situation where there was overproduction and under-consumption of goods which many describe "as being instrumental in setting off the recession in 1929." (Hall, 1998, p. 22)

Mariner Eccles, Chairman of the Federal Reserve from 1934 until 1948, in his memoirs entitled "Beckoning Frontiers," stated his belief that the fundamental cause of the Great Depression was a significant problem in the distribution of income… [END OF PREVIEW]

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