If you saw much of the news this weekend, then you heard the drumbeat of depression fears. Politicians, economists, and reporters are calling this the worst financial crisis since the Great Depression. They are NOT saying we are in a depression. They’re not even saying we’re definitely going to have one. But they are saying things will be tough for a while.

To calm your depression fears, here’s a brief rundown of the causes of the Great Depression, and an explanation of why things will be different this time.

What is an Economic Depression?
You might be surprised to learn that “depression” doesn’t have a formal definition. A recession is formally defined as two consecutive quarters of negative economic growth. Most consider a depression to be an extended and severe recession. The Great Depression was in fact two recessions: 1929-1934 and 1937-1939. World War II finally brought an end to the era.

What Made the Great Depression So Bad
The Great Depression was caused by two of the same things that caused our current crisis: excessive debt and a retraction in consumer spending. It was also the result of a stock market crash. Eventually the downturn pulled in much of the globe, although the suffering was the worst in the U.S.

To combat the downturn, the US government made several poor financial choices:

  • Increasing taxes
  • Limiting trade to protect US manufacturers
  • Allowing the money supply to shrink.

In addition, bank runs caused numerous banks to collapse. At the time, deposits were uninsured and people and businesses who had money in collapsing banks lost everything. Finally, the Dust Bowl occurred at the same time, which reduced food supplies for an already suffering people.

What Made that Economic Crisis Different from Today’s?
I heard a few things mentioned this weekend that made me believe this time will be different.

1. Bank insurance. Other than the IndyMac disaster, most bank failures have been orderly. No one besides those IndyMac customers with deposits over $100,000 have lost money. Instead, the banks have been seized and sold without a panicked bank run. FDIC insurance ensures that most people won’t lose their money if bank failures continue.

2. Low taxes. During the Depression, some taxes went up to 63%! No politician would even dream of such a drastic measure today.

3. Just-in-time inventory. CNN’s Ali Velshi pointed out that manufacturers during the depression were left with a lot of worthless merchandise, but today’s manufacturers typically only have a few days’ supply on hand. That reduces the possibility of manufacturers laying people off because of over-inventory.

4. An active Federal Reserve. Rather than shrinking the money supply, the Federal Reserve is acting in conjunction with international banking organizations to control interest rates and the money supply.

5. Improvements in food production. Although our environment is in trouble, we’re unlikely to see a repeat of the Dust Bowl, at least in this country. That was caused by recent developments in land cultivation being wrongly applied. Modern farmers are much better at limiting soil erosion.

Will We Suffer?
I do agree that we’re headed for a serious recession. I don’t think we’ll reach 25% unemployment, but families will have to tighten their belts and learn to stop relying on easy credit. Americans did that once already, and we can do it again.

About six weeks ago, I offered tips on how to prepare for a depression. That was before the current financial crisis, and I posted it not because I think we’re going to suffer a decade-long economic downturn, but because I believe you should prepare for the worst and hope for the best. When you grow up in California, you learn to be prepared for a disaster. I’m a good Californian.

Comments

One Response to “Are We Headed for a Major Economic Depression?”

  1. John Petty on October 24th, 2008 3:10 pm

    Here is an article about the fed chairman during the time of the Great Depression and what he thought caused it. The same thing is happening again for the same reasons. Please read:

    In Review: America’s Most Egalitarian Banker
    Marriner S. Eccles, Beckoning Frontiers: Public and Personal Recollections. New York: Alfred A. Knopf, 1951.
    At the start of the Great Depression, Marriner Eccles hardly seemed someone who might lead a charge against the economic orthodoxies that justified grand hoards of private fortune. By the early 1930s, after all, the Utah-born Eccles had become the top banker in the Mountain West, the organizer of the first multibank holding company in the United States.
    But Eccles had also come to understand, after watching the great speculative bubbles of the 1920s pop into massive misery, that prosperity — to endure — needs to be shared. Eccles began speaking out on that theme, shortly after the Great Depression began, and soon caught the attention of the early New Dealers.
    In 1933, Eccles would become an assistant secretary of the treasury. A year later, Franklin Roosevelt would appoint him to the Federal Reserve Board. He would become Board chair in 1935 and remain in that central position for the next 13 years. No one individual, over those years, had more of an impact on economic policy in the United States.
    Looking back on those years, in his 1951 memoir Beckoning Frontiers, Eccles would do his best to explain the impact he set out to make. Mass production, he noted at the outset, demands mass consumption, but people can’t afford to consume if the wealth an economy generates is concentrating at the top.
    In the years leading up to the Great Depression, that concentrating was accelerating. A “giant suction pump,” charged Eccles, “had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth.”
    “In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands,” Eccles observed, “the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.”
    Sound familiar? The decade of the 1920s that Eccles describes in his 1951 memoir comes across today as eerily familiar. Then as now, the U.S. economy was floating on a sea of debt.
    Then as now, inequality was hollowing out the nation. Eccles put the matter bluntly: “Had there been a better distribution of the current income from the national product — in other words, had there been less savings by business and the higher-income groups and more income in the lower groups — we should have had far greater stability in our economy.”
    How would Eccles have reacted to our current debt-ridden, war-torn economy? We can’t, of course, know for sure what Eccles would do. But we do know what he did. In 1942, during World War II, a high-powered team of New Deal officials that included Eccles proposed to President Roosevelt that “a ceiling of fifty thousand dollars after taxes should be placed on individual incomes.”
    In our current dollars, this $50,000 ceiling would equal about $700,000. What did FDR do with the Eccles proposal? He turned around and asked Congress to place a 100 percent tax on all individual income over $25,000.
    Congress would eventually set the nation’s top tax rate at 94 percent on all income over $200,000, and that top tax rate would hover around 90 percent for the next two decades, years that would see the greatest period of middle class prosperity in U.S. economic history.
    In 2005, the latest year with statistics available, America’s leading hedge fund managers and the rest of the nation’s top 400 income-earners faced a top tax rate of 35 percent. They actually paid, after loopholes, just 18.2 percent of their incomes in tax.
    Marriner Eccles would not approve.
    Stat of the Week
    In the two decades between 1986 and 2005, America’s top 1 percent of taxpayers saw their share of the nation’s income jump from 11.3 to 21.2 percent. Over those same years, the federal income taxes the top 1 percent paid dropped by an equally stunning margin, from 33.13 percent of total personal income in 1986 to 23.13 percent in 2005, the most current year with IRS stats available. Taxpayers needed to report at least $364,657 in 2005 to enter the top 1 percent.
    About Too Much
    Too Much is published by the Council on International and Public Affairs, a nonprofit research and education group founded in 1954. Office: Suite 3C, 777 United Nations Plaza, New York, NY 10017. E-mail: editor@toomuchonline.org

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