Why did the Great Depression happen?
The Great Depression was caused by a combination of stock market speculation fueled by borrowed money, overproduction in agriculture and industry, fragile banking systems without adequate regulation, the contraction of international trade through protective tariffs, and policy failures by governments and central banks that deepened the crisis instead of alleviating it.
The Great Depression was not caused by any single event but by a cascading series of failures in the economic system that exposed the fundamental fragility of unregulated capitalism. The stock market crash of October 1929 was the dramatic starting point, but the underlying vulnerabilities had been building throughout the 1920s.
The 1920s boom was built on unstable foundations. Stock prices had risen far beyond what corporate earnings justified, driven by speculation on margin — investors borrowing money to buy stocks, betting that rising prices would cover their debts. Consumer credit expanded recklessly, allowing people to buy goods they couldn't afford. Agricultural prices had been depressed throughout the decade as wartime demand evaporated and mechanization increased production. The wealth of the 1920s was concentrated at the top — the bottom 60% of Americans barely participated in the prosperity, limiting the consumer demand needed to sustain production.
The crash itself was devastating but not necessarily sufficient to cause a decade-long depression. What turned a financial crisis into an economic catastrophe was a series of policy failures. The Federal Reserve, instead of expanding the money supply to support the banking system, actually contracted it — choking off credit when the economy desperately needed liquidity. Over 9,000 banks failed between 1929 and 1933, wiping out the savings of millions of depositors and destroying the mechanism through which credit reached businesses and consumers.
International dimensions amplified the crisis. The Smoot-Hawley Tariff of 1930, designed to protect American industries, triggered retaliatory tariffs worldwide and collapsed international trade by roughly 65%. European nations, still burdened by war debts and dependent on American loans, were dragged into the downturn. The gold standard, which tied currencies to fixed gold values, prevented governments from expanding the money supply or devaluing their currencies — the very tools they needed to fight the crisis.
The fundamental lesson was that markets were not self-correcting. Classical economics held that prices and wages would adjust to restore equilibrium, but in practice, falling prices increased the burden of debt, triggering more bankruptcies and more unemployment in a vicious deflationary spiral. It took the massive government spending of World War II — exactly the kind of fiscal stimulus that economists like Keynes had advocated — to finally end the Depression.