IB History Economic Factors Including the Banking System and Trade Notes

Economic factors: Banking collapse and the breakdown of trade

A credit economy created systemic risk

1. American growth depended heavily on borrowed money. Households used instalment credit, firms borrowed to expand, and investors purchased shares on margin.
   1. Buying on margin magnified both gains and losses. Investors often paid only a fraction of a share's price and borrowed the remainder from brokers.
   2. Rising asset prices concealed weak foundations. Credit expanded faster than sustainable income and made confidence central to economic stability.
   3. Debt connected consumers, banks, and markets. When borrowers defaulted, losses moved rapidly through the financial system.

The banking system transmitted panic

1. The United States had a fragmented banking system. Around 25,000 banks operated in 1929, many of them small institutions tied to one locality or sector.
   1. Unit banking limited diversification. A local crop failure or factory closure could threaten a bank whose loans were concentrated in that community.
   2. Depositors lacked federal insurance. Before the Federal Deposit Insurance Corporation was created in 1933, a bank failure could erase household savings.
   3. Rumour could create a bank run. Depositors rushed to withdraw cash, forcing banks to sell assets at depressed prices.
   4. More than 9,000 US banks suspended operations between 1930 and 1933. Failures destroyed savings and reduced the credit available to businesses and farms.

Bank failure reduced demand and investment

1. Credit contraction affected the real economy. Businesses could not finance inventories, wages, or new equipment.
   1. Firms responded by cutting production. Lower output led to layoffs, which reduced household purchasing power.
   2. Falling demand caused further closures. The cycle linked financial panic to industrial unemployment.
   3. Deflation increased the real burden of debt. As prices and wages fell, fixed repayments consumed a larger share of income.
   4. Debtors sold assets to meet obligations. Distress sales pushed prices down and intensified balance-sheet weakness.

Canada avoided bank failures but not depression

1. Canada's branch-banking system was more concentrated. Large banks operated networks across provinces and could spread risk more effectively than many US unit banks.
   1. No Canadian chartered bank failed during the 1930s. Institutional stability protected depositors from the scale of US banking panic.
   2. Financial stability did not prevent economic collapse. Canada depended heavily on exports to the United States and Britain.
   3. Wheat, timber, minerals, and manufactured goods lost markets. Falling demand and prices produced unemployment and regional hardship.
   4. The comparison separates banking failure from depression. A stronger banking structure softened one mechanism while trade dependence transmitted another.

International lending spread the downturn

1. US finance had supported global recovery during the 1920s. American banks lent to governments and businesses in Europe and Latin America.
2. The flow of credit became unstable after 1929. Banks recalled loans, refused renewals, and redirected capital toward liquidity.
   1. Debtor countries lost access to dollars. They struggled to service foreign debts and finance imports.
   2. Latin American governments faced severe balance-of-payments pressure. Export earnings fell at the same time that debt obligations remained.
   3. Some states suspended debt payments. Default preserved scarce foreign exchange but damaged relations with foreign creditors.

World trade collapsed

1. Trade had already been weakened by wartime debts and tariff barriers. The post-war economy lacked a stable system for recycling surpluses and financing deficits.
2. The Smoot-Hawley Tariff raised US duties in 1930. The law protected domestic producers but encouraged retaliation by trading partners.
   1. Retaliatory tariffs reduced export markets. Countries attempted to preserve employment at home by restricting imports.
   2. World trade contracted by roughly two-thirds between 1929 and 1933. Falling prices, lower demand, tariffs, and exchange controls reinforced one another.
   3. Export-dependent economies were especially exposed. A decline in one or two commodities could collapse government revenue and employment.

Commodity dependence destabilized Latin America

1. Many Latin American economies relied on a narrow export base. Brazil depended on coffee, Chile on copper and nitrates, Cuba on sugar, and Argentina on meat and grain.
2. Commodity prices fell sharply after 1929. Export earnings contracted even when producers maintained or increased output.
   1. Governments collected less customs revenue. Reduced income limited their ability to maintain services or fund relief.
   2. Import capacity also collapsed. Without foreign exchange, states could not buy machinery, fuel, and manufactured goods.
   3. The crisis encouraged import substitution industrialization. Governments promoted domestic production to replace goods that had become unaffordable or unavailable.

The gold standard constrained recovery

1. The gold standard tied currencies to fixed gold values. Governments defended exchange rates by maintaining reserves and financial confidence.
2. Defending gold often required higher interest rates and budget restraint. These measures reduced demand when economies needed expansion.
   1. Countries that left gold gained room to act. Currency depreciation could improve export competitiveness and permit lower interest rates.
   2. The sequence of departure mattered. Earlier abandonment generally allowed earlier monetary recovery, although national outcomes differed.
   3. The system transmitted deflation internationally. Pressure on one country's reserves forced contraction that reduced demand for another country's exports.

The crisis spread through international finance and commodity shocks

1. Weak disclosure concealed corporate risk. Limited federal oversight allowed companies and investment trusts to present optimistic valuations that encouraged speculation without reliable information about underlying assets.
2. The Federal Reserve responded inconsistently. It sometimes raised interest rates to defend gold reserves even as banks failed, deepening deflation and making existing debts harder to repay.
3. The money supply contracted sharply. Bank closures and cautious lending reduced circulating credit, so lower spending caused further falls in output, employment, and prices.
4. Industrial production magnified the downturn. Mass-production sectors depended on steady consumer credit, making automobiles, appliances, steel, and construction vulnerable when households postponed purchases.
5. Unequal income distribution weakened consumption. High-income households saved a larger share of earnings, while many workers lacked the purchasing power needed to absorb expanding industrial output.
6. The collapse of Creditanstalt intensified fear. The Austrian bank's failure in 1931 contributed to a European financial crisis that threatened Germany and reinforced international capital flight.
7. Britain left the gold standard in 1931. Sterling depreciation improved policy flexibility and demonstrated that recovery could require abandoning fixed exchange commitments.
8. The United States suspended gold convertibility in 1933. Roosevelt's action allowed monetary expansion and weakened deflationary pressure, although recovery remained incomplete.
9. Prairie debt combined with environmental crisis. Low wheat prices, drought, and mortgage obligations devastated farm income and weakened businesses throughout western Canadian communities.
10. Brazil supported coffee prices through intervention. The government purchased and destroyed surplus stocks to limit collapse, showing how commodity crisis encouraged a stronger economic role for the state.
11. Mexico expanded economic nationalism. Depression-era pressures strengthened arguments for land reform, resource control, and reduced dependence on foreign capital, culminating in oil expropriation in 1938.

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