Though economic activity was already declining moderately in many countries by early 1929, the U.S. stock market crash in October of that year really started the Great Depression. The American stock market boom, which had seen stock prices double between early 1928 and September 1929, was built on borrowed money. Two factors explain why. First, the wealth gap (or income inequality) between America’s rich and poor reached its greatest extent in the twentieth century in 1928–1929. One percent of Americans then held 70 percent of all America’s wealth. (Similar wealth gaps were present in other countries as well.) This meant the other 99 percent of Americans had to divide up the remaining 30 percent of wealth for all their purchases. Eventually, with not enough money to go around, the 99 percent had to borrow to make even basic purchases — as a result, the cost of farm credit, installment loans, and home mortgages skyrocketed. Then a point was reached where the 99 percent could borrow no more, so they stopped buying.

Second, wealthy investors and speculators, as they accumulated more and more wealth, took increasingly greater investment risks. One such popular risk was to buy stocks by paying only a small fraction of the total purchase price and borrowing the remainder from their stockbrokers or from banks — about $4 out of every $10 in bank loans went to buy stocks. Even people of more modest means speculated in this way, believing, as had been true throughout the “Roaring Twenties,” that the market would just keep going up. Such buying “on margin” was extremely dangerous. When prices started falling, the hard-pressed margin buyers started selling to pay their debts. The result was a financial panic. Countless investors and speculators were wiped out in a matter of days or weeks, and the New York stock market’s crash started a domino effect that hit most of the world’s major stock exchanges.

The financial panic in the United States triggered a worldwide financial crisis. Throughout the 1920s American bankers and investors had lent large sums to many countries, and as panic spread, New York bankers began recalling their short-term loans. Frightened citizens in Europe, Australia, Canada, several countries in Latin America, and elsewhere began to withdraw their bank savings, leading to general financial chaos. The recall of American loans also accelerated the collapse in world prices, as business people dumped goods in a frantic attempt to get cash to pay what they owed.

The financial chaos led to a drastic decline in production in country after country. Between 1929 and 1933 world output of goods fell by an estimated 38 percent. Countries now turned inward and tried to go it alone. Many followed the American example, in which protective tariffs were raised to their highest levels ever in 1930 to seal off shrinking national markets for American producers only.

Although historians’ opinions differ, two factors probably best explain the relentless slide to the bottom from 1929 to early 1933. First, the international economy lacked leadership able to maintain stability when the crisis came. Neither the seriously weakened British nor the United States — the world’s economic leaders — stabilized the international economic system in 1929. Instead Britain and the United States cut back international lending and erected high tariffs.

Second, in almost every country, governments cut their budgets and reduced spending instead of running large deficits to try to stimulate their economies. That is, governments needed to put large sums of money into the economy to stimulate job growth and spending. After World War II such a “counter-cyclical policy,” advocated by the British economist John Maynard Keynes (1883–1946), became a well-established weapon against depression. But in the 1930s orthodox economists generally regarded Keynes’s prescription with horror.