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Right before Great depression in Nineteen-Twenties there was a huge credit boom. For the first time ever people were buying everything on credit. This was extended to the extent that even the investments like purchasing of stocks in stock market was done through loans with as little as 10% down payment. Also, before that the only way to get really rich was by creating, inventing, manufacturing, producing, innovating and investing in production. In twenties for the first time people start making money, even in terms of billions of dollars without doing any of such ventures. Due to the huge expansion in credit, and stock market boom, this new genre of millionaires and even billionaires was making money just by buying and selling stocks. For the first time people were getting rich just by buying and selling paper documents like securities and bonds.
The major cause of this over extended credit was the governments new fractional reserve requirements. In accordance with those new requirements, banks were required to hold as reserves, only a fraction of credit they extended. So, now, with reduced requirements for capital reserves, banks had lot more to land. This caused a widely and deeply inflated demand for goods and services, resulting into very large expansion in production, backed up by heavy investments. A huge bubble was created which was not sustainable by average and median income at the time. As usual people thought that the growth in prosperity and wealth will last forever.
Of course that was not the case. Production was raised to the levels which were not sustainable even with the inflated demand due to over extended consumer credit. Gradually it became harder to sell the goods produced which depressed the prices. The depressed prices resulted into decreased margins. The depressed margins caused flattened wages at first then decline in wage levels and finally lay-offs. This trend depressed the demand even more. Depressed demand in turn put more pressure on prices and a vicious downward spiral started.
Cuts in wages, hours and layoffs also made people to spend less. A larger and larger number of people started defaulting on their loans and credit. As the number of defaults increased, banks started to run out of money. So, the bank failures ensued. Bank failures made people think that their money is not safe in banks anymore. So, the bank run-offs were started, complicating the situation even more, and making it harder for even relatively sound banks to survive. People were now hoarding more and more cash and assets in homes.
Hence, investments, including purchases of stocks at stock market got depressed, too. Reduced demand for investments in stock market depressed the stock prices. Depressed and falling stock prices caused selling rallies, as the investors tried to save their investments before the prices fall even further or before markets crashes. Indeed, market did crash in the middle of all those sell offs. Therefore, market crash was just a symptom or consequence of what was going on for years. Contrary to common belief stock market crash did not start Great Depression. It was started long before that happened.
Stock market crash just made the depression official and obvious to everyone. Unfortunately, any predictions before such a catastrophic event are usually dumped as conspiracy theories, and it is only after fact that general public comprehend and elite accept the reality. Virtually, when the denial is not possible, anymore. I have seen it, several times, in my lifetime. For example, very few people before the 2008 crash realized and accepted that the market was over inflated and about to crash. Most people just labeled estimates and forecasts of market crash as hype or speculation. This just compounded the losses of so many real estate investors, as they kept on investing in declining market while most of the capital flowing in, was through reckless bank loans.
Same thing happened in 1929. Since there were lots of over investments, and most of those were based on loans from banks. So, when businesses start to fail, banks took a larger part of that hit. This was the major cause to bank failures and bank run-offs. Stock market finally crashed after a long boom which seemed to last forever at that time. By 1933 the productivity and GNP losses were as high as 50% and unemployment was 25% which means that one out of every four workers was unemployed.
Families suffered a lot in that period. Soup kitchens were opened all over the United States, by charities, all of which had long lines. Shanty camps termed as Hoovervilles were spread all over the country. Millions were homeless. Thousands of banks and tens of thousands of businesses went under. People and children were seen sleeping on streets and digging dumpsters for food. Plight was global. China was pretty much the only known major country in world, which avoided the depression. Russia also had a very short and shallow recession. This created the illusion that socialism or Communism may be the better economic ideologies. Socialists and Communists all over the world blamed capitalism for it.
In his last days Hoover introduced some government interventions, and then Roosevelt introduced a series of new government interventions and regulations called “New Deal”. None of those were able to solve the problem. Rather the Depression kept prolonging. In the middle of all that mess, World War 2 broke down and problem was solved. Surprise! Country after country gave up gold standard, and huge amounts of money were printed to fund war efforts. Large number of men were enrolled and sent to war. Women were left to pick other war related jobs, at home.
So, this is what happened in Great Depression:
1. Government regulation of fractional reserves destroyed the markets.
2. Stock market crashed. People lost their faith in stock market.
3. Demand for government interventions rose.
4. Governments were able to give up gold standard and print large amounts of money to grow their size and power.
5. Newer government regulations were enforced increasing the control of government on economy.
6. New government agencies were formed to increase the size and control of government.
7. Governments were able to go to war without any significant resistance from people who were starving and welcomed the prospects of having jobs.
8. Government was able to raise taxes.
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