Banking

In the late 1920’s, the United States followed the Gold Standard, and thus commercial banks
kept a portion of their reserves in gold coins and bullion. Any increase in gold coins or
bullion (from mining or flows from abroad) would increase the money stock. Similarly, any
decrease in reserves would decrease the money stock.
During the Great Depression, money stock fell because of the sudden panic created by the
stock market crash. Banking systems have always relied on depositors’ confidence that they
will have access to their money whenever needed. If this confidence is shaken (because of
failure of a large commercial bank or financial institution), people dash to withdraw their
money to avoid the loss that they might face if the bank fails. As the banks held only a small
part of depositors’ money as reserves, a sudden attempt to convert these reserves into cash
put the banks into a tight spot. The banks could not even borrow from other banks as
depositors rushed to demand their money from almost every bank.
Beginning in the 1930’s, a series of such panics shook the banking system. Numerous banks
in Midwest and Border States turned broke, and one of the largest commercial banks of New
York, the private Bank of United States collapsed in 1930. As a consequence, 744 banks
collapsed in the first ten months of the year. Similar ‘run on the banks’ happened in 1931 and
1933, and approximately 4000 banks failed by 1933. As depositors withdrew their money
from the banks, the banking sector lost its reserves and had to cut down on their credit facility
and deposits which became one of the major factors for economy to further collapse.
The graph shown below depicts the sharp decline in the money supply during the Great
Depression. Whereas M1 constitutes the currency and coins, M2 constitutes time deposits in
addition to coins and currency.
Stock Market
During the early 1920s, approximately two to three million shares were exchanged every day
on the New York Stock Exchange. However, owing to the popularity of the stock market as a
‘cash cow’ and easy credit facilities, this number touched twelve million by late 1928 and
early 1929. However, with the crash in October 1929 the average value of a common stock
fell by over 40% by mid-November, 1929. By 1932, the stock market had lost over 90% of its
value in 1929 and stocks that were worth $87 billion were only valued at $18 billion.
Businesses, banks, and investors were completely decimated. The stock market crash and its
effects can be charted from the graph given below.

Trade
As the global economy came to terms with the initial stages of the Great Depression in 1929,
the main objective of the United States was to protect its farmers and American jobs from its
competitors. In 1930, Congress enacted the Tariff Act, 1930 also known as the Smooth-
Hawley Tariff Act under which tariffs on over 20,000 imported goods were raised
substantially. The average import tariff on imported goods during 1921-1925 was about
25.9%, but it was hiked to about 50% during 1931-1935. As a result, other nations also
increased tariffs on American made goods as a retaliatory measure, which hampered
American exports and imports by more than 50%. In monetary terms, American exports
declined from $5.3 billion (1929) to about $1.7 billion (1933), and prices dwindled by around
33%.
Deflation
Because of the unprecedented stock market crash and consequent ‘run on the banks’,
financial institutions were hardly left with any reserves, which substantially increased the
borrowing costs for the population. As a result, spending on goods and services declined
sharply which caused businesses to cut production, reduce prices and fire workers. American
Gross National Product declined by over 25% (from $104 billion to $76.4 billion) in the
space of three years 1929-1932 (as depicted in the graph below), and farm income declined
from $12 billion to $5 billion. However, the borrowers’ burden did not ease, and with
reduced prices and lower incomes, many could not repay their loans. Consequently, defaults
and bankruptcy increased manifold which caused many banks to fail.