Examkin

Question

Difficulty: MediumCauses of the Great Depression

During the decade since the armistice, the United States has transitioned from a debtor nation to the world’s primary creditor. American private loans have rebuilt Europe, enabling Germany to make reparations to France and Great Britain, who in turn pay their wartime debts back to the United States Treasury. However, this system hinges entirely on the continuous outflow of American capital. Should domestic opportunities, such as the roaring stock market, divert these investment funds inward, the international financial network will collapse under the weight of unpayable debts.

— Financial analyst review of international banking, 1928

Which of the following developments in the early 1930s did the financial relationship described in the excerpt contribute to most directly?

  1. A synchronized global economic collapse resulting from the sudden cessation of American foreign investments.Answer
  2. B
    The complete withdrawal of the United States from international trade in order to preserve absolute diplomatic neutrality.
  3. C
    The federal government's refusal to protect domestic industries with tariffs due to a strict adherence to laissez-faire economic theory.
  4. D
    The immediate stabilization of European currencies through the expansion of New Deal industrial recovery grants.

Answer

A synchronized global economic collapse resulting from the sudden cessation of American foreign investments.
The interwar international economy was heavily dependent on a circular flow of capital where American investors lent money to Germany, which Germany used to pay reparations to the Allies, who then used those funds to pay war debts to the United States. When the U.S. stock market boom of the late 1920s diverted American capital inward, and the subsequent 1929 crash halted lending entirely, this international debt loop collapsed, triggering bank failures in Europe and spreading the economic depression globally.

Step-by-Step Solution

1
Analyze the stimulus to identify the core economic mechanism described.
The stimulus describes the circular international debt system of the 1920s (U.S. loans to Germany, German reparations to the Allies, Allied war debt payments to the U.S.) and warns of its dependence on continuous American capital outflow.
Understanding the dependencies in the 1920s international economy is necessary to predict the impact of a disruption.
2
Connect the disruption mentioned (American investment funds being diverted inward) to historical events of the late 1920s and early 1930s.
As the U.S. stock market boomed in the late 1920s and then crashed in 1929, American capital was pulled back from Europe, halting the flow of loans.
Connecting the stimulus's hypothetical scenario to real historical actions allows for causal reasoning.
3
Evaluate the options to identify which development directly resulted from this halt in capital outflow.
The cessation of U.S. loans caused the collapse of the European debt payment cycle, leading to bank failures in Europe and a synchronized global depression.
Selecting the option that reflects the global contagion of the depression matches the causal chain outlined in the stimulus.

Key Concept

The international debt structure of the 1920s and its role in spreading the Great Depression globally.
Rate this question

Topics

Causes of the Great Depression

More questions from this topic