Will our current situation end up worse than the Depression?

I know that I'm usually silly or light-hearted on this blog but Jen's post got me thinking seriously and I turned to my Husband, CFA and asked him the same questions for the millionth time. Here's the response I got. Hopefully it will ease some concerns.

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The US and global economic response to this crisis will most likely cause the US to avoid a catastrophe similar to what we saw in the 1930's (the Great Depression or "GD"). But first, we must point out what made the 1930's GD a GD.

1.) countries around the world were tied to the gold standard (meaning currencies could be exchanged for a certain amount of gold held in reserves...aka the amount of money floating around could not be more than the amount of gold that was in existence)
2.) policy mistakes (Smoot-Hawley, fiscal stimulus that came too late, fed increased interest rates)
3.) between 1 in 4 and 1 in 3 people were unemployed

To add a little background, during the 1900's the US was an agricultrually and industrially driven economy (think of farming and assembly lines). We also happened to export quite a bit of those products (meaning we sold our stuff to other countries). As a result, these huge sectors, to a certain extent, relied on our foreign trade partners. This is where #1 comes into play. Our trading partners got into trouble with the gold standard for a variety of reasons (several banks failed)...their ability to buy US ag/industry goods, was severely diminished. With a lot less people buying, this caused the US' supply of goods to build up, and prices for those goods to tank. So eventually, the US ended up importing more than it exported...and the people at the time did not like that. So In response, (this is where #2 applies), congress enacted smoot-hawley tariff act, which was done with the intention of making it cheaper for Americans to buy American goods. Our trade partners freaked out (justifiably so) and put up their own trade barriers, making things even worse as they decided to buy even less american goods. That's when the deflationary spiral really took hold. Farmers don't want to buy their own goods...they want to sell them...so we had a bunch of farmers with nobody to sell to. Lots of farmers defaulted on loans because of this. In fact, enough farmers defaulted that banks started going under and people started losing savings (which caused the infamous "bank runs"). With the financial sector in ruin, companies couldn't invest in productive capacity because they couldn't secure loans. The Federal reserve made matters worse by actually raising interest rates, in the attempt to stem the massive outflow of investments made in the US. With interest rates in the stratosphere, there was certainly no way anyone could get much less afford loans. With virtually no economic activity, a country can't produce jobs for its people. That's where #3 came from.

This time around, our policy-makers have the advantage of history. But whats the same this time around and whats different?

Same:

1.) bank failures (lehman brothers bankruptcy really f'd everything up)
2.) deflation (housing prices are going down)
3.) trade protectionism (China actively manipulates its currency so their goods are always cheaper than everybody else's)

Different:

1.) the federal reserve cut interest rates to 0 (making it cheap for banks to lend to each other and thus to consumers, also to keep mortgage rates low)
2.) the FDIC insures deposits, so if there is a bank failure, nobody loses their savings
3.) no gold standard (abandoned during the 70's) means we can print as many dollar bills as we want...so if lots of $ is destroyed b/c of bad loans or b/c banks are too chicken to lend, the treasury can always just print more money to replace what's been lost.

This time around, though, China is more like the US was during the 1930's...the US has been spending like crazy for over a decade now, and all we have to do now is save. The money we save will be regurgitated by the US Government in the form of tax cuts or rebates on buying a new home (basically, the $800bn fiscal stimulus plan that's been in the headlines). So unemployment today will probably not go higher than 1 in 10 (its currently ~1 in 12).

China and a lot of asian countries are more susceptable to a GD, imo. They have invested so much money over the past decade, catering to their exporting sectors that they forgot to invest in themselves. Now that the US and Europe are no longer spending money, asian countries face a tough road of developing an actual consumer-led economy, similar to the US'.

This is certainly a Great Recession, but by no means is it a Great Depression. The policy response of our government (no matter how bad the press makes their ideas sound), the ability to print money and the focus on re-engendering confidence in the system are what will keep us out of another GD.