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The Factors that Led to the Great Depression of the 1930s Had a Lot in Common with Today’s Economy, but That Depression Was Very Different.
The coronavirus or COVID19 has affected all aspects of our lives and most notably has affected the stock market. While the stock market is not always an indicator of overall economic health for an economy one way or the other, it’s the canary in the coal mine that reflects important economic factors.
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What is worth watching is the effect COVID19 has on all factors affecting the economy, not only in the U.S. but globally. Certain impacts lead to a recession, and if those impacts are long-term, economies fall into what is described as a depression.
What is a Depression?
The term “economic depression” does not have a formal definition. Traditionally, it has been described as an extended and severe recession. Not surprisingly, recessions and depressions are never announced immediately.
It’s not until some key factors continue in a certain way over a period of time that economists reluctantly declare that a recession is occurring, and much later surrender to the realities of a depression.
What is a Recession?
Unlike a depression, a recession has a formal definition: “Two consecutive quarters of shrinking GDP.”
GDP stands for gross domestic product. It represents everything we produce over a specific period. Coming out of 2019, U.S. GDP growth stood at 2.3% in the last quarter. In the first quarter of 2020, it’s currently running at 1.6%. If the second quarter of 2020 sees a reduction from 1.6% by the end of the quarter, it will fit the formal definition of a recession.
However, most economists will wait until the end of the third quarter of 2020 before they even think to declare a recession, while ignoring that a third quarter of falling GDP is the sign of a depression.
The Unemployment Factor
In addition to a consistent decline in GDP is a rise in unemployment. While job numbers have been rising as of late, the effect of COVID19 on numerous industries has already become apparent.
- Professional sports venues across all sports have shut down their seasons and the jobs that accompany them in both stadiums and other peripheral suppliers.
- Retailers are either closing or reducing their hours, particularly in clothing and general merchandise.
- Restaurants and bars are closed in many parts of the U.S. for an unknown period of time.
- Theaters, gyms, and other spaces and places where large groups of people gather in close contact are closing.
- Cruise ship companies and many vacation resorts have shut down or closed for an unknown period of time.
- Airlines have seen a dramatic falloff of up to 50% and will all be bankrupt by the end of May if nothing changes.
- Tourist destinations in the U.S. are either closing or seeing a rapid decline.
As a result, 18% of U.S. workers have already lost jobs or hours since the impact of coronavirus hit about a week ago.
As businesses and locations that combine large numbers of people for any length of time continue to close or reduce hours, the impact on employees for all of those businesses will grow. Some stopgap measures have been implemented by the federal government to cover loss of employment but for now that only averages two weeks.
What happens if the closures continue? The obvious answer is growing unemployment which was one of the primary causes of the Great Depression of the 1930s.
In a press conference on March 16th, President Trump stated that social distancing and the effects of COVID19 could extend well into the summer. He also stated that there is a possibility of a recession. That’s longer than two weeks for anyone receiving brief unemployment benefits.
What Happened in the 1930s?
Most people are unaware that the Great Depression actually consisted of two severe recessions. One lasted from 1929 to 1934 and the second lasted from 1937 to 1939. A variety of factors caused the recessions of the 1930s including poor government policies related to management of the money supply, banking, interest rates, and taxes.
Another factor was poor land management that led to the dust bowl and rampant unemployment across the farm states and foreclosures on homes and farms. To give you a point of reference, from 1929 to 1932, global GDP fell by about 15%. This was much more than the 1% decline during the Great Recession, which started in 2008.
Many policies and laws have been put into place to forestall some of the mistakes of the 1930s including better management of interest rates and the money supply by the Federal Reserve Banks, the creation of the FDIC to insure cash deposits in banks up to $250,000, lower taxes relative to the 1930s, and better land management practices.
All of these changes should forestall a depression, but the depression we may be facing will be more similar to what happened in Japan in the 1980s. It was driven by real estate and credit speculation and the deflation and falling wages that ensued have continued to this day.
The point is that there is no set formula for a recession and the driving factors can come from anywhere, including a pandemic.
A New Definition of Economic Depression
Based on the past patterns leading to recessions and eventual depressions worldwide, two factors have now been identified as indicators of a depression.
- GDP must shrink by at least 10% (total GDP contraction).
- The economic downturn must last longer than three years.
Other signals of a recessionary cycle leading to a depression include growing unemployment, foreclosures, falling wages, credit defaults, deflation, and reduced economic activity. And that last point brings us back around to COVID19.
Reduced Economic Activity
COVID19 is causing an abrupt economic shock that some economists think is more unnerving than the 2008 financial crash, which caused the worst downturn since the Great Depression.
Widespread closures and cancelations seem certain to lead to more losses and layoffs, already reflected in a stock market down 28% in less than a month. A manufacturing survey hit its lowest level since 2009 on March 16, a sign of things to come. “This feels much worse than 2008,” according to Harvard economist Jason Furman.
This all gets back to the fundamental feature of a depression: duration of the recession. If the necessary response to COVID19 continues to have the severe impacts currently indicated… a depression is inevitable.
10 Ways to Prepare for this Depression
You can, in fact, take control of the situation at least to some degree. Here are 10 things to do to prepare for an economic depression:
1. Pay off debt starting with credit cards.
Eventually, you can move on to other debts. There’s no need to pay off your mortgage, but if you have paid all of your debts and want to make some principal payments, you can consider it, but only after you’ve taken the next step.
2. Shore up your emergency fund for at least 6 months of expenses.
In the event you are laid off, this fund can get you through. However, the standard recommendation is for a 6-month emergency fund even in the best of times. If you’re concerned, you can extend that to the time frame you’re most comfortable with.
3. Build your network, both professional and personal.
If you lose your job, your professional network can be the fastest path to new employment. Also, people need to help and support each other in desperate times, so a strong social network is a smart idea.
If restaurants continue to be closed for any length of time and you don’t know how to cook, now’s the time to learn. It also saves money and keeps you out of public restaurants. The ability to can and preserve foods is also a good skill and a cost saver.
5. Learn to shop wisely. Shop for sales and only buy what you need.
With many retailers closed or closing, shopping may not be the issue it once was but even then, shop wisely. If you need it, buy it. But ask yourself if you really need it.
To a large degree, we depend on imports of produce. If for any reason those imports are affected, the cost and availability of produce could increase significantly. Plant a garden and take a second look at those flower beds. You may be better off planting strawberry plants or vegetables rather than zinnias.
7. Learn to live below your means.
Again, only buy it if you need it. Here are five frugal tips that will save you some money.
8. Keep your car in good condition. Especially if it’s paid off.
A new car payment adds to the debt.
9. Buy classic style clothes, not the latest trend.
Now is the time to think functionally not fashionably.
10. Avoid aggressive investments.
The stock market is deceptive and unless you have a strong grasp of investment fundamentals, stay with the safe investments.
Monitor What’s Happening
What has been true about all past recessions and depressions is that economists and governments don’t announce them until they have become woefully obvious. At some point, they are likely to point back to March 2020 as the beginning of the depression.
Don’t allow yourself to be surprised. Consider the 10 steps listed above and keep a close eye on reports related to GDP and unemployment.
The stock market can be a fool’s game and a fool’s indicator of the underlying strengths or weaknesses in an economy. Statistics related to GDP and unemployment paint a more accurate picture. With any luck, the steps being taken worldwide will curb the pandemic.
Recent reports from Hong Kong indicate life is getting back to normal. How their economy or any other economy in the world recovers has yet to be seen.
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