As we look back on the Great Depression, we are reminded of the profound impact this economic crisis had on society. This dark period in history, from 1929 to 1939, has taught us valuable lessons that policymakers like politicians and central bankers could apply to today’s economy. In this blog post, I will explore ten key takeaways from this tumultuous time, using my thoughts and opinions to provide a fresh look at these essential lessons as we face some new similar dynamics in the economy, interest rate policy, and changes in globalism in recent years.
Diversify the Economy: Relying Heavily on One Industry or Sector Can Have Disastrous Consequences
The 1920s saw a significant dependence on the stock market and manufacturing, which made the economy susceptible to shocks. Embracing economic diversity is crucial to prevent future catastrophes. We can ensure long-term stability and growth by promoting a diverse and well-balanced economic landscape.
In 2023, we have an economy centered on the stock market, as so many have money invested for retirement in their 401ks. This has led politicians and central banks to focus too much on keeping the stock market going higher instead of just letting the market work out supply and demand for shares based on earnings. Real estate prices have also been relied on too much for increasing net worths in the early 2000s and again after 2018. The U.S. economy has also become too centered on the tech sector, not industrial-based businesses. We need healthy businesses in all sectors and companies that make things for a healthy economy.
Prudent Lending Practices: Reckless Lending and Excessive Debt Contribute to Financial Collapse
Responsible lending practices and regulations are essential to prevent crises like the Great Depression. Both banks and individuals must exercise caution when it comes to borrowing and lending money, as excessive debt played a significant role in the financial collapse.
While there are similarities between the lending practices before the Great Depression and those in more recent times, it is essential to note that significant changes and regulations have been implemented to prevent similar crises. However, analyzing the similarities can provide valuable insights to help us understand potential risks and vulnerabilities in the financial system.
- Easy credit and lax lending standards: Before the Great Depression, banks were more lenient in lending practices, often providing loans without thorough assessments of borrowers’ ability to repay. This easy credit-fueled speculation and increased debt levels. We have recently seen similar trends in periods preceding financial crises, such as the subprime mortgage crisis of 2007-2008, where banks extended loans to high-risk borrowers with poor credit histories. In 2020, the markets flooded with money from central banks worldwide, adding trillions of dollars for speculation in stocks, crypto, and real estate.
- Overleveraging: Before the Great Depression, many individuals and businesses were overleveraged, meaning they had borrowed heavily to invest in assets like stocks and real estate. This overleveraging magnified the effects of market downturns, as borrowers struggled to meet their debt obligations when asset prices fell. In recent years, we have seen instances of overleveraging, particularly during 2020, with company hiring and government debt around the world increasing at historical highs versus the national GDP of many countries.
- Speculative bubbles: Lax lending practices before the Great Depression contributed to the formation of speculative bubbles in the stock market and other asset classes. When these bubbles burst, they led to significant losses and widespread financial turmoil. Similar patterns have been observed recently, with asset bubbles emerging in various sectors, such as the housing market in the early 2000s.
- Financial innovation: The period leading up to the Great Depression saw the development of new financial products and investment vehicles, contributing to increased risk-taking and speculation. In recent decades, we have also witnessed the rise of complex financial instruments and derivatives, which played a significant role in the 2007-2008 financial crisis. The new risk in 2023 has been with the decline in the value of U.S. government bonds as the Federal Reserve raises interest rates; the old low-yield bonds decline in value as new bonds are more attractive.
Despite these similarities, it’s important to recognize that regulatory frameworks and oversight have not significantly improved since the Great Depression. Reforms such as the Glass-Steagall Act (1933), which separated commercial and investment banking, were repealed in 1999, during the Clinton Administration, though some parts remain, including the FDIC. The Dodd-Frank Wall Street Reform and Consumer Protection Act (2010), which aimed to strengthen financial regulations and consumer protections, was implemented to mitigate the risks associated with irresponsible lending practices. On March 14, 2018, the Senate passed the Economic Growth, Regulatory Relief, and Consumer Protection Act, exempting dozens of U.S. banks under a $250 billion asset threshold from the Dodd–Frank Act’s banking regulations. On May 22, 2018, the law passed in the House of Representatives. On May 24, 2018, President Trump signed the partial repeal into law. Central banks continue to fail to provide a more active role in monitoring and stabilizing the financial system to prevent the recurrence of a crisis on the scale of the Great Depression.
The recent Silicon Valley Bank and Signature Bank failures are more examples of the failure of oversight. Many experts believe the speed of raising interest rates caused the banks to fail as their bond-holding values plunged, and customers wanted their deposits back due to the risks.
Monetary Policy: Central Banks Must Act Decisively to Stabilize the Economy and Financial System During Crises
The Federal Reserve’s failure to adequately respond to the Great Depression by maintaining monetary stability and preventing bank failures exacerbated the crisis. Today, central banks must be proactive in maintaining monetary stability during times of crisis to minimize economic damage and facilitate recovery. The new bailouts that politicians and the central banks provide for the banking system eliminate the risk of depositors losing their accounts but create new risks to excessive risk-taking by banks and put stress on the value of the U.S. dollar due to all the money used for bailouts could cause inflation.
Fiscal Policy: Government Intervention Through Fiscal Policy Can Mitigate the Effects of Economic Downturns and Stimulate Recovery
Increased public spending and investment can stimulate recovery and help counteract the negative effects of recessions. Governments play a vital role in softening the blow of economic downturns by employing endless fiscal policies to stimulate the economy by giving out money through business loans, unemployment checks, and public assistance for food. The U.S. government learned the lesson of the Great Depression and is not very liberal with giving out money during recessions.
Income Inequality: Addressing Income Inequality Contributes to a More Resilient Economy
High levels of income inequality were present before the Great Depression, which can reduce consumer spending and destabilize the economy. Ensuring a more equitable distribution of wealth through fair pay and training programs can lead to a more stable and resilient economy that benefits everyone. The difference between CEO and front-line worker pay has never been such a wide gap. This is not healthy for the economy,
International Cooperation: Coordinated Efforts Are Crucial to Addressing Global Economic Challenges
The Great Depression was a global phenomenon, and protectionist policies like the Smoot-Hawley Tariff Act worsened the crisis. In our interconnected world, we must recognize the importance of international cooperation and coordination in tackling worldwide economic challenges and fostering global prosperity. Tariffs are a tax on buyers by driving up prices. Fair and open trade keeps inflation down and can create jobs for the creation of products to export.
Social Safety Nets: These Programs Help Reduce the Human Toll of Economic Crises and Support Recovery
The hardships faced by millions during the Great Depression led to the creation of crucial social safety nets, such as unemployment insurance, social security, and minimum wage laws. By maintaining these programs, governments can alleviate the human toll of economic crises and support recovery efforts for a more equitable society. The safety nets have never been broader or more comfortable than they are now in the Western world.
Regulation and Oversight: Preventing Fraud, Speculation, and Excessive Risk-Taking Leads to Economic Stability
The lack of oversight and regulation in the financial sector was a contributing factor to the Great Depression. Implementing robust regulations and vigilant oversight can help prevent financial instability by curbing fraudulent practices, speculative excesses, and high-risk behavior. Cryptocurrencies, NFTs, and SPACs taught new speculators some old lessons from 2020-2021 as they created bubbles that popped.
Financial Education and Awareness: Empowering Individuals to Navigate Economic Challenges
Public understanding of financial matters such as saving, investing, and managing debt is crucial for economic stability. Promoting financial literacy and education can empower individuals to make informed decisions and contribute to a more resilient economy. There has never been more readily available access to financial education than there is now.
Preparedness and Adaptability: Being Ready for Economic Downturns and Adapting to Change Is Essential
The Great Depression taught us the importance of preparing for economic downturns and adapting to changing circumstances. This includes having contingency plans, maintaining emergency funds, and developing the ability to respond to new economic realities. By cultivating preparedness and adaptability, we can better weather the storms of economic uncertainty and emerge stronger. The Great Depression generation learned lessons of frugality, appreciation, and being prepared that stuck with them all their life.
The lessons learned from the Great Depression offer invaluable insights into building a more resilient and prosperous society. By embracing economic diversity, encouraging responsible lending, prioritizing monetary stability, implementing effective fiscal policies, addressing income disparities, fostering international collaboration, establishing social safety nets, strengthening financial regulations, promoting financial literacy, and cultivating preparedness and adaptability, we can apply wisdom gained from this historical period to shape a brighter future. By internalizing these principles, politicians and policymakers could be educated and empowered to navigate the complex world of economics and work together to create a more even playing field and stable society for future generations.