Income inequality was a critical problem because America’s new mass-production economy depended on ever-increasing consumption, and higher income groups could consume only so much, no matter how much of the nation’s wealth they controlled. While the expansion of consumer credit helped hide this fundamental weakness, the low wages earned by most Americans drove down demand over time. Cutbacks in demand forced manufacturers to reduce production, thereby reducing jobs and increasing unemployment. In the days before unemployment insurance, this placed an increased burden on families to make ends meet and dragged down the demand for consumer goods even further. By 1926, as a result of lagging purchasing power, the growth of automobile sales had begun to slow, as did new housing construction—signs of an economy heading for trouble.

At the same time, the wealthy few used their disproportionate savings to speculate in the stock market and risky real estate ventures. To encourage investments, brokers promoted buying stocks on margin (credit) and required down payments of only a fraction of the market price. Without vigilant governmental oversight, banks and lending agencies extended credit without taking into account what would happen if a financial panic occurred and they were suddenly required to call in all of their loans. To make matters worse, the banking system operated on shaky financial grounds, combining savings facilities with speculative lending operations. With minimal interference from the Federal Trade Commission, business people frequently managed firms in a reckless way that created a high level of interdependence among them. For example, Samuel Insull, who owned a gas and electric utilities empire, was the chairman of the board of sixty-five companies, a director of eighty-five others, and the president of an additional seven corporations. This interlocking system of corporate ownership and control meant that the collapse of one company could bring down many others, while also imperiling the banking houses that had generously financed them.

Rampant real estate speculation in Florida foreshadowed these dangers, as private developers and the state government promoted tourism and land purchases. In many cases, investors bought properties sight unseen, as speculators and unscrupulous agents worked under the assumption that land values would continue to increase forever. However, severe storms in 1926 and 1928 abruptly halted the increase in land values. Land prices spiraled downward, speculators defaulted on bank loans, and financial institutions tottered.

Throughout the 1920s, fortunes plummeted for farmers as well. Despite the growing urbanization of the nation, farmers still made up one-third of the population. Declining world demand following the end of World War I, together with increased productivity because of the mech-anization of agriculture, drove down farm prices and income. Between 1925 and 1929, falling wheat and cotton prices cut farm income in half. The collapse of farm prices had the most devastating effects on tenants and sharecroppers who were forced off their lands through mortgage foreclosures. Around three million displaced farmers migrated to cities, where they had to compete with unskilled laborers for factory jobs and often found themselves among the ranks of the unemployed.

Internationally, the United States encountered serious economic obstacles. World War I had destroyed European economies, leaving them ill equipped to repay the $11 billion they had borrowed from the United States. Much of the Allied recovery, and hence the ability to repay debts, depended on obtaining the reparations imposed on Germany at the conclusion of World War I (see chapter 20). Germany, however, was in even worse shape than France and Britain and could not meet its obligations. Without a prosperous Europe, the American economy suffered. In 1924 the U.S. government sent Charles G. Dawes, a banker and soon to become Coolidge’s vice president, to negotiate with Britain, France, and Germany to find a solution to their mutual problem. Under the terms of the eventual agreement, the United States provided loans to Germany to pay its reparations. In turn, Britain and France reduced the size of Germany’s payments. The result was a series of circular payments. American banks loaned money to Germany, which used the money to pay reparations to Britain and France, which, in turn, used Germany’s reparations payments to repay debts owed to American banks. What appeared a satisfactory resolution at the time ultimately proved a calamity. In undertaking this revolving-door solution, American bankers added to the cycle of spiraling credit and placed themselves at the mercy of unstable European economies. Compounding the problem, Republican administrations in the 1920s supported high tariffs on imports, reducing foreign manufacturers’ revenues and therefore their nations’ tax receipts, making it more difficult for these countries to pay off their debts.