The Super Summary of World History - Alan Dale Daniel [164]
This is important to the national economy because, like the money supply, it affects a bank’s willingness and ability to loan. As loan funds dry up businesses find it harder to expand, hire new workers, or buy better equipment. On the other hand, if too much money is available and being loaned out below market rates this causes an economy to “heat up” or begin expanding faster than it should, resulting in inflation hampering the economy and destroying its ability to function if the malady gets bad enough.[198] A nation’s central bank tries to ensure that enough money is available for loans, at reasonable rates, so the economy grows at a steady but sustainable rate, without much inflation, and no hefty contractions (depressions and deep recessions). This is difficult, because economies respond slowly to changes in the money supply, interest rates, and changes in monetary valuation. Months can pass before economic changes become evident, and by then some other change may be necessary to keep the economy on track (steady but reasonable expansion without much inflation and reasonable contractions or corrections). [199]
When the money supply gets tight and loans are hard to obtain businesses stagnate and often stop hiring or start laying workers off to save money. Fewer employed people results in other businesses selling fewer items and they start to lay off workers. This cycle, if continued, can trigger a depression and destroy an economy. When the money supply is easy and loans are easy to obtain businesses may borrow to expand and hire more workers. More employed people means more goods are sold. If many people try to buy the same items the prices will increase under the rules of supply and demand. If these prices continue to rise they can cause runaway inflation which can also destroy an economy. It is a tricky balancing act to keep economies on track.
Prior to the advent of the central bank concept, financial markets set the interest rates banks could charge for loans without government interference. Coupled with the gold standard, the market handled the variables of money supply, monetary value, and the interest rates charged for loans very well before the depression. During the Great Depression, nations went off the gold standard and began economic manipulation, eliminating the free market financial mechanisms setting interest rates and other monetary variables. This was a major and permanent change in the financial world.
Tariffs
Tariffs are critical to international trade. tariffs are a financial charge placed on goods coming in from foreign nations, thus making foreign-made goods more expensive. The international community knows that if one nation raises tariffs the nations negatively impacted will also raise tariffs. In practice, England might raise tariffs 10 percent on cars from the United States, and in response the United States will raise tariffs on English tea by 15 percent. Then England will retaliate for that US move, and back and forth it goes until both nations price themselves out of the markets for tea and cars. In 1930, the Congress of the United States passed very high tariffs on goods from other nations in the Smoot Hawley Tariff Act. This could not have come at a worse time. The world’s nations responded by rising their tariffs and international trade began to implode, especially for exports from the United States. Fewer export goods sold because the overseas price took buyers out of the market. This tariff act, along with retaliatory acts passed by other nations, prolonged and increased the severity of the depression and made the disaster truly global.
The Contraction Starts
By 1929 in the United States businesses faced new problems getting loans because the money supply was shrinking.