The destruction of capital associated with the Great Depression started with WW-I. The initial capital losses occurred in 1919. Subsequent debt creation led to capital destruction in other sectors of the economy, particularly in financial instruments. But these capital losses were not recognized until 1929 and later. This sudden recognition changed the spending behavior of business and consumers.
Specifically, war demand pushed up prices of commodities and manufactured goods which led to a massive investment around the world in producing additional amounts of these products. When the war ended, these capital investments became redundant and nearly worthless.
Central banks encouraged huge expansions in money supply to offset the weakness in the agricultural and manufacturing sectors. Not surprisingly, these loans did not go into manufacturing and agriculture but instead led to the widespread speculative run-up in real estate and stock prices. Sound familiar?
Joseph Schumpeter referred to this post WW-I period as "hollow prosperity". Eugen Weber wrote a definitive book about France in this period titled "The Hollow Years".
During the 1920s the farm sector in nations including Australia, Argentina, and the United States were hit heavily leading to massive farm foreclosures and related losses for the lenders involved.
The depression in the US allegedly began when a money center bank in Chicago failed after suffering major losses on agricultural loans and in local agricultural banks. People seem to recall this had something to do with the "dust-bowl" but don't see the connection with WW-I and why this same disaster in agricultural business was occurring around the world.
By the time agricultural lenders were failing, stocks and real estate had reached unsustainable levels. Actually real estate in some regions, such as Florida were already on the decline as their bubble rose faster and peaked earlier.
Deluded Monetarists like Milton Friedman came to the conclusion that the Great Depression occurred because the central bank did not create new debt sufficiently quickly in a large enough supply.
The reality is that the post-WW-I weakness in manufacturing and farming should have led to the expected recession. The explosion of debt creation merely masked the problem and in turn led to the bubble in financial instruments which created the Great Depression when they collapsed.
Monetarist "solutions" actually created the Great Depression.
As Joseph Schumpeter summarizes:
"Policy does not allow a choice between depression and no depression, but between depression now and a worse depression later.
Inflation pushed far enough would undoubtedly turn depression into the sham prosperity so familiar from European postwar (WW-I) experience, and would, in the end, lead to a collapse worse than the one it was called in to remedy.
For recovery is sound only if it does come of itself. For any revival which is merely due to artificial stimulus leaves part of the work of depressions undone and adds, to an undigested remnant of maladjustment, new maladjustment of its own which has to be liquidated in turn, thus threatening business with another worse crisis ahead."
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