Great Depression: Turning Point and Recovery

The gold standard was the primary transmission mechanism of the Great Depression. Even countries that did not face bank failures and a monetary contraction first hand were forced to join the deflationary policy since higher interest rates in countries that performed a deflationary policy led to a gold outflow in countries with lower interest rates. Under the gold standard's price–specie flow mechanism, countries that lost gold but nevertheless wanted to maintain the gold standard had to permit their money supply to decrease and the domestic price level to decline (deflation).

There is also consensus that protectionist policies, and primarily the passage of the Smoot–Hawley Tariff Act, helped to exacerbate, or even cause the Great Depression.

Gold Standard

The Depression in international perspective.

Some economic studies have indicated that just as the downturn was spread worldwide by the rigidities of the gold standard, it was suspending gold convertibility (or devaluing the currency in gold terms) that did the most to make recovery possible.

Every major currency left the gold standard during the Great Depression. The UK was the first to do so. Facing speculative attacks on the pound and depleting gold reserves, in September 1931 the Bank of England ceased exchanging pound notes for gold and the pound was floated on foreign exchange markets.

Japan and the Scandinavian countries joined the United Kingdom in leaving the gold standard in 1931. Other countries, such as Italy and the United States, remained on the gold standard into 1932 or 1933, while a few countries in the so-called "gold bloc", led by France and including Poland, Belgium and Switzerland, stayed on the standard until 1935–36.

According to later analysis, the earliness with which a country left the gold standard reliably predicted its economic recovery. For example, The UK and Scandinavia, which left the gold standard in 1931, recovered much earlier than France and Belgium, which remained on gold much longer. Countries such as China, which had a silver standard, almost avoided the depression entirely. The connection between leaving the gold standard as a strong predictor of that country's severity of its depression and the length of time of its recovery has been shown to be consistent for dozens of countries, including developing countries. This partly explains why the experience and length of the depression differed between regions and states around the world.

Breakdown of International Trade

Many economists have argued that the sharp decline in international trade after 1930 helped to worsen the depression, especially for countries significantly dependent on foreign trade. In a 1995 survey of American economic historians, two-thirds agreed that the Smoot–Hawley Tariff Act (enacted June 17, 1930) at least worsened the Great Depression. Most historians and economists blame this Act for worsening the depression by seriously reducing international trade and causing retaliatory tariffs in other countries. While foreign trade was a small part of overall economic activity in the U.S. and was concentrated in a few businesses like farming, it was a much larger factor in many other countries.

The average ad valorem rate of duties on dutiable imports for 1921–1925 was 25.9% but under the new tariff it jumped to 50% during 1931–1935. In dollar terms, American exports declined over the next four years from about $5.2 billion in 1929 to $1.7 billion in 1933; so, not only did the physical volume of exports fall, but also the prices fell by about 1⁄3 as written. Hardest hit were farm commodities such as wheat, cotton, tobacco, and lumber.

Governments around the world took various steps into spending less money on foreign goods such as: "imposing tariffs, import quotas, and exchange controls". These restrictions triggered much tension among countries that had large amounts of bilateral trade, causing major export-import reductions during the depression. Not all governments enforced the same measures of protectionism. Some countries raised tariffs drastically and enforced severe restrictions on foreign exchange transactions, while other countries reduced "trade and exchange restrictions only marginally":

• "Countries that remained on the gold standard, keeping currencies fixed, were more likely to restrict foreign trade". These countries "resorted to protectionist policies to strengthen the balance of payments and limit gold losses". They hoped that these restrictions and depletions would hold the economic decline.
  
  
• Countries that abandoned the gold standard, allowed their currencies to depreciate which caused their balance of payments to strengthen. It also freed up monetary policy so that central banks could lower interest rates and act as lenders of last resort. They possessed the best policy instruments to fight the Depression and did not need protectionism.
  
  
• "The length and depth of a country's economic downturn and the timing and vigor of its recovery are related to how long it remained on the gold standard. Countries abandoning the gold standard relatively early experienced relatively mild recessions and early recoveries. In contrast, countries remaining on the gold standard experienced prolonged slumps".

Effect of Tariffs

The consensus view among economists and economic historians (including Keynesians, Monetarists and Austrian economists) is that the passage of the Smoot-Hawley Tariff exacerbated the Great Depression, although there is disagreement as to how much. In the popular view, the Smoot-Hawley Tariff was a leading cause of the depression. According to the U.S. Senate website the Smoot–Hawley Tariff Act is among the most catastrophic acts in congressional history

German Banking Crisis of 1931 and British Crisis

The financial crisis escalated out of control in mid-1931, starting with the collapse of the Credit Anstalt in Vienna in May. This put heavy pressure on Germany, which was already in political turmoil. With the rise in violence of Nazi and communist movements, as well as investor nervousness at harsh government financial policies. Investors withdrew their short-term money from Germany, as confidence spiraled downward.

The Reichsbank lost 150 million marks in the first week of June, 540 million in the second, and 150 million in two days, June 19–20. Collapse was at hand. U.S. President Herbert Hoover called for a moratorium on Payment of war reparations. This angered Paris, which depended on a steady flow of German payments, but it slowed the crisis down, and the moratorium was agreed to in July 1931. An International conference in London later in July produced no agreements but on August 19 a standstill agreement froze Germany's foreign liabilities for six months.

Germany received emergency funding from private banks in New York as well as the Bank of International Settlements and the Bank of England. The funding only slowed the process. Industrial failures began in Germany, a major bank closed in July and a two-day holiday for all German banks was declared. Business failures were more frequent in July, and spread to Romania and Hungary. The crisis continued to get worse in Germany, bringing political upheaval that finally led to the coming to power of Hitler's Nazi regime in January 1933.

The world financial crisis now began to overwhelm Britain; investors around the world started withdrawing their gold from London at the rate of £2.5 million per day. Credits of £25 million each from the Bank of France and the Federal Reserve Bank of New York and an issue of £15 million fiduciary note slowed, but did not reverse the British crisis. The financial crisis now caused a major political crisis in Britain in August 1931.

With deficits mounting, the bankers demanded a balanced budget; the divided cabinet of Prime Minister Ramsay MacDonald's Labour government agreed; it proposed to raise taxes, cut spending, and most controversially, to cut unemployment benefits 20%. The attack on welfare was unacceptable to the Labour movement. MacDonald wanted to resign, but King George V insisted he remain and form an all-party coalition "National Government".

The Conservative and Liberals parties signed on, along with a small cadre of Labour, but the vast majority of Labour leaders denounced MacDonald as a traitor for leading the new government. Britain went off the gold standard, and suffered relatively less than other major countries in the Great Depression. In the 1931 British election, the Labour Party was virtually destroyed, leaving MacDonald as Prime Minister for a largely Conservative coalition.