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The above answer is only partially correct. A series of events led to the Great Depression, and in fact there was no "atmosphere of economic fear and doubt" prior to the collapse of the stock market; quite the contrary was true. Everyone believed that happy days were here to stay, and the crash was sudden and unexpected. Among the causes of the depression:
- New farm equipment allowed for increased production from farming. Contrary to what most farmers expected, the increased production led to lower prices because there was more supply than demand. Farmers did not understand the relationship between price and supply, and continued to over-produce, which pushed farm prices even lower. Farmers, already in debt, were unable to pay their debts, and the farming sector collapsed.
- This was not nearly as important as the misconception that the economy had begun a period of permanent growth. This encouraged people to participate in speculative investments in an attempt to "get rich quick." A chilling analogy can be drawn between this situation and the real estate bubble which collapsed in the most recent recession. Investments in real estate climbed wildly, particularly in Florida real estate. Many who invested never owned or even saw the property; rather they signed binder agreements to purchase the property and sold the binder agreement at a higher price. This bubble was bound to collapse at some point, which it did.
- The belief in permanent growth caused banks and bankers to make loans which they otherwise would not have made. Many of these loans defaulted with great loss to the banks. The end result was the banking crisis which saw many banks close and "runs" on banks.
- Business and industry refused to accept the fact that the economy might be slowing down. They continued production at full scale, resulting in large buildups of inventory. When it suddenly became apparent that supply had outstripped demand--a situation similar to the farm problem--factories ceased production until excess inventory could be sold off. With production ceased, workers were laid off work. These workers then could not make major purchases or even pay their bills, which also led to many bank failures.
- The stock market crash of 1929 did not cause the Great Depression, but was symptomatic of the problems which beset the economy. Many people with little business acumen were making wild investments in the stock market expecting it to climb permanently. These speculative investments pushed stock prices to unrealistic levels which could not be sustained; and ultimately the market collapsed.
No one event caused the Great Depression, but a major element in all the varied causes was the inability--or refusal--to recognize the cyclical nature of the economy.
There are so many causes of the Great Depression that there is not space to mention them all here. However, historians, especially economic historians, point to three key factors.
First, although the 1920s are often considered a period of prosperity, farm prices, textiles, and coal, three of the pillars of the American economy, still experienced declines or slow growth. Farmers, in particular, struggled to pay their mortgages, which had implications for the banking industry.
Second, the 1920s saw a massive increase in income disparity, which was masked by the affluence of a monied elite. The percentages of Americans living in poverty increased steadily throughout the 1920s.
Finally, consumer debt reached dangerously high levels, a development that had ripple effects throughout the economy. The major growth sectors of the 1920s economy, including consumer goods and automobiles, had been based to a great extent on consumer borrowing, and as consumers acquired too much debt and had to cut back on purchases, businesses saw demands for their products decline rapidly, with devastating effects.
These conditions contributed to the atmosphere of economic fear and doubt that climaxed with the stock market crash in the fall of 1929 and the series of bank panics that followed.
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