Are We Headed for a Major Economic Depression?

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.

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