The twenties were a time of economic prosperity and hope for North America and some parts of Europe. Countries began to rebuild themselves physically and financially after the war, and as war bonds began to mature, new capital began to stream into the pockets of the individual. Consumption in both the industrial and private sectors began to create an economic boom and production levels soared well above full employment capacity. This influx of money and prosperity made investment in companies a very lucrative business venture because profit margins and stocks dividends were making people all over the world a small fortune. Brokers began to involve any person who had extra money to spend in the world of stocks and bonds, and international trade markets began to develop and flourish. Money was an abundant, fluid entity, and economies were thriving.
During this decade, corporations were given the capital to expand. However, the amount of money that had been invested and continued to be invested in these firms, was far greater than the amount that could be spent on efficient production and development. This disparity led to the overinflation of stock prices, a state where the value of the stocks far outweighed the value of the company. This was a very dangerous level to maintain because if people realized that their stocks could only go down in price, they would sell at the higher price levels and would jeopardize the longevity of these firms. In addition, banks also used stocks as collateral for loans, taking the face value of the stocks as a solid asset. If the market were to rapidly and spontaneously deflate, not only would individual debtors lose their ability to repay loans, but the banks would lose their stability because the collateral held on these loans would become worthless.
In 1929 the worst case scenario happened and the world wide stock market fell into a state of chaos. In the proceeding years banks fell, corporations crumbled and businesses cut back on all aspects of production. The economy was entering a decade of recession that was later called The Great Depression, and its repercussions would be felt across the entire world.
The Great Depression is often characterized by the microeconomic variables involved, as these tend to be more dramatic tales. Implanted in the minds of men and the writings of history are tales of personal struggle and hardship, where individuals fought for social stability caused by the deplorable conditions forced upon the masses. However, it is the long term changes in macroeconomic policy, changes that mark this decade in history as one of the most progressive periods in Europe’s economic history, that lay the foundations for future generations of capitalists to flourish. By dealing with the outdated policies of laissez-faire economics and the question of the gold standard, the economic superpowers of Europe, Britain, Germany and France, forge the new standard for European economics after the Great Depression.
Laissez-faire economics were based on the principal that the economy of a country should be left to run by itself without any government interference. Men like Adam Smith and J.S. Mill wrote explicit essays advocating free enterprise and unrestricted capitalism. This method of economic conduct worked well until the private sector was hit with the sudden and drastic onset of the depression. The depression took away the confidence of buyers all over the world and shriveled consumption statistics, leaving individual firms very few options about how to handle the price level, wages and unemployment. Leading ultimately to a downturn in aggregate production, governments were forced to intervene in business affairs to speed recovery along, and changes in government policy had to be made if the country was to survive. The only problems with policy changes were that governments were not sure which policies they should implement, and in the end each country took a different stance to this question based on their individual economic standings in the world.
Closely tied to the economic standings of these countries was the question of what currency standard should be used. The gold standard which was originally set up prior to the first World War to equate all the major economic countries’ currencies into a common value, was becoming weakened by constant fluctuations of individual currencies. Since each country is independent in and of itself, the rates of inflation and the rates of production were not always uniform across the countries. If a country was to keep with the standard, major controls would have to be implemented within a country to keep their economy prosperous.
After World War I, Britain was the strongest economic voice in Europe, having per capita income definitively higher than France’s or Germany’s.1 Having this strong economic base to work from, Britain was able to deal with the impacts of the gold standard on their economy much better than other European countries. From, the start Britain knew their currency was overvalued according to the gold standard and they set about to immediately rectify this problem. After a few failed attempts at working within the system, Britain left the gold standard behind in 1931, devaluing its currency by about one-third2 of its original value. Inflation did occur after the change, however the rate of costs did not increase to the severe extent other states were forced to endure.
In response to earlier demands and pressures to move away from the laissez-faire system of economics, a British citizen by the name of John Keynes began to develop what would be the new economic policy for not only Britain, but the United States as well. His theory stressed the importance of government expenditures and taxation, as he felt they were related to the variables of employment, wages and the price level. In his publication General Theory, Keynes pointed out that the depression severely limited the ability of individual firms to correct any production problems they were having by themselves.3 The decreased demand for goods caused by inflation was commonly followed by firms lowering the prices of their goods in attempts to increase demand. This lowering of prices, however, would force a firm to lower wages or cut back on employment numbers to save on cost of production. With lowered prices and lower wages, it was found that the real income, or the ratio of costs to an income, remained for the better part unchanged and consumption figures did not rise. This is where Keynes suggests that the government change its spending to support higher prices and inflation. He figured that if the prices were encouraged to rise, allowing the income of the workers to remain the same, the value of real wages would decrease, meaning that firms could raise employment and thus production.4 With renewed production capacity and higher employment rates, the consumption statistics could rise once again and start to restore life to the economy.
The German economic reaction to the Great Depression was drastically different than that of Britain since they did not experience the economic boom that the rest of the world had during the early twenties. After the first World War, Germany was forced to make large reparation payments to France, believed by some economic historians to be overly punitive and opressive.5 Because of this economic strain the country suffered from what is known as hyperinflation, where the values of the German mark depreciated to the point where it became valueless if the gold standard was to be maintained. Trade, both nationally and internationally ground to a halt as the financial system collapsed. A new currency was introduced in replace of the old, and Germany carried onward in a pattern of economic policies that supported an economic deflation as a last resort defensive economic tactic.
Despite foreign loans Germany’s economy was crippled and there was nothing the government could do to recover from this shock.6 With rising unemployment and with the onset of an even greater depression in the early 1930’s, Germany’s prospects for economic recovery were bleak. Nevertheless, when Adolf Hitler was elected to office and later set himself up as a military dictator, he attempted to turn Germany’s crumbling economy around using an intensive job creation strategy. Under this program Hitler upgraded his military power and the great numbers of young men inducted into the military lowered the jobless rate in Germany. However, since the state lacked the capital to maintain this level of employment on its own, Hitler initiated the second phase of his quest to force the recovery of the German economy, the conquest phase.7 He struck the highly industrialized regions of Czechoslovakia first and incorporated their resources to those of Germany. The wars continued and as territory after territory was captured, the economic hardships of Germany were passed along to these conquered peoples. Production and employment dramatically increased in the German homelands, and the economy started to re-stabilize itself.
The last of the three major economic entities in Europe, France, was the slowest to respond to the pressures of the gold standard. By setting the gold standard value of the Franc to its prewar values knowing that it was only valued at one-fifth8 the amount, the French economists were taking a large risk. Because France did experience significant upturns in 1926 and 1928, their economy was sheltered through the first signs of the depression in the early thirties. This prosperity combined with increasing government control over the economy, led France to hold on to their overvalued currency until 1936 when pressures to change became too great.
Since France held its currency value for such a long period of time, French goods became relatively expensive when compared to other goods on the world market. In order to remain competitive in the world market the French adopted a policy of deflation whereby the government would limit expansion or development of new firms, as well as placing strict limits on production. This policy would not increase world trade by much, but would maintain the incomes of local firms by raising and sustaining internal prices as well.9 Increased tariffs were also implemented to raise the price of imports and increase the consumption of domestic goods. In the long run, these policies did not bring about prosperity and the effects of the depression caught up to France. They were forced to devalue the Franc and leave the gold standard behind.
Since France had already gained experience in having a government controlled economy, their conversion to a new long term economic policy was already halfway completed. They ceased their deflationary tactics and began to expand production capacity once again. France did not want to adopt a system like that of Britain where deficit spending was encouraged to speed economic recovery, so they took a parallel road to recovery.10 The French government raised taxes and shifted the burden of economic recovery onto the firms that they had protected for the last decade. Unlike Britain or Germany, whose private sector could not pull out of the downward spiral, the French companies managed to recuperate individually.
In conclusion, the prominent long term macroeconomics effect of the Great Depression was the escape from a laissez-faire system of economics. While each country responded differently to the shockwaves of the economic downturn, the idea that the government sought increased control over the economy was uniform. The British began to develop an economic system that turned out to be the key foundation of modern economic theory based on action reaction equations. The Germans, while they were eventually defeated and forced to develop different systems, experienced a militaristic view of the economy where efficiency and production were stressed. The French rounded off the group by creating an environment that promoted the longevity of the firm thorough the manipulation of its government fiscal policy. In the end, had the prolonged depression not occurred, it is hard to say if we would have had a need to develop these policies that are still with us in just about every country in the world today. It is, however, definite that the recession forced these changes to occur.