Step 1 – Andrew Mellon, who is the Treasury Secretary, advocates tax and spending cuts under Warren Harding and Calvin Coolidge; freeing up capital allows the economy to begin growing.
(Keep in mind in 1920-1921 there was a deep recession but, with very little government intervention, the economy was rebounding a year later.)
Step 2 – Federal Reserve Chairman Ben Strong in the mid 1920s begins to increase the money supply and cut interest rates, creating an artificial increase in credit.
Step 3 – Companies which are already doing well issue stock, then use the money to buy foreign bonds (lending money abroad so they can keep buying stuff from the U.S.). The return on these bonds make the companies look more profitable than they are, and traders begin using the credit created by Fed Chairman Ben Strong to speculate. Therefore the stock prices went up beyond the actual real profitability of these companies.
Step 4 – Eventually in 1929, valuations hit their ceiling and prices begin to fall. This forces margin calls (people having to sell to pay their loans since their stocks are falling), which causes prices to fall even further. The market crashes.
Step 5 – The economy finds it hard to recover as Herbert Hoover signs the Smoot-Hawley tariff which taxes a number of foreign goods. Many other countries then do the same in retaliation, hurting trade and further weakening the economy.
Step 6 – U.S. policy influenced by economist Irving Fisher (who failed to predict the crash and lost almost everything because of it) focuses on measures to prevent the fall of asset prices (which were overvalued … duh), slowing down the ability of the economy to discover what the true value of these assets are so that they can be sold – and that the economy can again move forward.
Step 7 – Herbert Hoover raises taxes to 62% in 1932.
Step 8 – FDR becomes president, raises taxes to the 90%s and continues to fight asset price deflation, dragging out the liquidation even further.
Step 9 – While GDP and umeployment improve during World War II (building tanks and drafting soldiers will do that), it’s not until the tax and spending cuts after the war ended that private investment and quality of life truly begin to improve.
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