We’ve talked about the current recession before and we know that the main thing that triggered it is the subprime mortgage crisis which originated from several investment banks. But what about a more severe economic downturn called depression?
According to Wikipedia:
In economics, depression involves sustained, long-term downturn economic activity. While recession is seen as a part of a normal business cycle, depression is a sustained recession. It is characterized by abnormal increase in unemployment, falls in the availability of credit, shrinking output and investment, numerous bankruptcies, reduced amounts of trade and commerce, as well as highly volatile relative currency value fluctuations, mostly devaluations.
In 1929, the greatest of all depressions called “The Great Depression” is the most severe that caused a tremendous wipeout of huge money in most economies around the world. It was the longest and most wide spread depression in the history of US.
So what caused the great depression? My curiosity in this subject matter led me to study what were the causes of this severe economic downturn before.
If we are about to study what are its causes, we can eliminate it to happen again. Let’s examine one by one what are the probable causes of this “Great Depression”.
Wall Street Stock Market Crash of 1929. One of the most severe stock market crashes in the history of US was the one that occured in October 29, 1929 which was also known as the famous Black Tuesday. Prior to that event, after a long time of wealth and excess money in the system, a lot of speculators came into rise. People just buy a lot of stocks based solely on speculation of gains due to the continued increase in stock prices that reached peak levels. They were even borrowing money just to buy stocks.
However, panic among investors started and a lot them began selling and dumping their shares. In the financial world, this is called “bubble burst“. A lot of bankers met before to discuss how can they tame investors’ fear. Some of them bid and purchased huge blocks of shares to pump up stock prices and bring back investors’ confidence in the stock market. Unfortunately, this tactic just temporarily resolved the problem. Stocks prices continued to fall and by the close of market on October 29, 1929, $30 billion worth of stocks were wiped out in just 1 week.
Debt Deflation. Since a lot of people borrowed money which they used to buy stocks prior to the stock market crash of 1929, there was a limited supply of money circulating in the economic system after the crash happened.
This fact led to the dry up of availability of loans for business owners. They can no longer borrow money in banks to expand their business operations and cover their costs. As a result, a lot of companies declared bankruptcies and laid off a lot of their employees causing a huge increase in unemployment rate in most economies.
Bank failures. With the debt deflation, a lot of banks closed down. Bank deposits were uninsured and so as these banks shut down, a lot of people lost their savings. Those banks who survived were too cautious to lend new loans to businesses. This aggravated the situation leading to less and less expenditures thereby forcing more and more companies to close down which added to the mounting unemployment problem.
Depressed consumer buying. With the unemployment rate kept on rising, more and more people hold to their dear cash and just don’t want to spend. This exacerbated the situation as business deals and transactions continued to dry causing businesses to lose profits and eventually close down.
Inaction by the FED. The FED or Federal Reserve is the Central Bank of the US. It is considered as one of the most powerful among central banks around the world. The inaction by the FED contributed to the Great Depression. By not acting on the situation, the FED allowed the money supply in the system to shrink and did not even bother to bail out huge banks that failed. One of these banks was New York Bank of the United States which produced panic and bank runs among local and small banks.
Gold standard. One of the reasons why the FED did not act to limit the decline in money supply was the regulation called “gold standard”. Back then, the amount of credit issued by the FED should be backed up by gold. By the late 1920s, just before the stock market crash began, the FED already hit its maximum allowable credit that could be backed up by the gold in its possession. Since the FED had hit its limit on allowable credit, any reduction in gold in its vaults had to be accompanied by a greater reduction in credit.
Smoot-Hawley Tariff Act. As business began failing, the US government created the Smoot-Hawley Tariff Act in 1930 to help protect American companies. Unfortunately, this act aggravated the depression by seriously reducing the foreign trades between the US and other countries imposing high imports taxes.
Drought in the Dust Bowl Years. There was a drought that occured in the Mississippi Valley in the 1930s that exacerbated the situation of the Great Depression. This pushed a lot of farmers to cultivate more despite the high costs of soil conservation. Unfortunately, since there was a Great Depression happening at that time, they ended up selling their farm lands.
Here are some other images of The Great Depression:
People need to line up to get their food during The Great Depression. Poverty was rampant and there was a tremendous food shortage exacerbated by the drought that happened in the 1930s.
A lot of people were left unemployed. They began walking in the streets advertising themselves just to find job that could provide them income to support their families.
WHAT ARE THE LESSONS LEARNED DURING THE GREAT DEPRESSION?
Recently, we’ve experienced another recession that triggered a lot of bank failures causing a rise in unemployment rate. A continued recession may lead to a depression which obviously, all of us don’t want to happen. Here are some of the lessons that I learned after studying the causes of the great depression.
Learn to Save. In times of “rainy days” like this, learn to save. You will never know when will you be laid off in your work. At least when you have enough savings, then you can survive the effects of a depression.
Manage Risks. Yes, we need to invest to grow our money. However, we should manage the risks involved in investing. If you are not educated enough into a particular type of investment, then don’t engage yourself into it. Don’t just rely on speculations without even analyzing it.
Don’t carry too much debt. Too much debt because of a relaxed credit availability triggered The Great Depression. If you cannot ascertain yourself that you can use that debt as a good debt vs. a bad debt, then don’t accumulate debts. Always make sure that you pay your debts on time.
Luckily, the recent recession did not prosper further because of the help extended by the major central banks around the world. As they see the money supply depletes in the economic system, they began pumping the economy with money through tax incentives, huge loans, and direct intervention in the stock market. They even bailed out some of the huge banks on the verge of bankruptcy just to save jobs so as to prevent a further domino effect on small industries.
Image Source: Google Images