What Caused the Great Depression and Can It Happen Again?

At its root, the Great Depression was caused by the stock market crash in October of 1929 and the end of the economic expansion experienced during the Roaring Twenties. However, the root of the issue experienced with the populace back then goes a little deeper than this. After the stock market crashed there were “Runs on Banks” (i.e. the general population lost confidence in the banking system and tried to withdraw all cash within clusters and all at once). Moreover, there was a severe contraction in monetary policy and inappropriate level of total money supply within the United States. The severe contraction in monetary policy was done in order to help maintain the gold standard, but unknowingly ended up added flames to the fire, and further restricted economic activity. This in turn led to decreases in lending, investment and any subsequent capital expenditures. In addition to the above, lending was scaled back on an international level—essentially eliminating much of the needed liquidity in order to benefit free market trade and enterprise.

The impact to the economy was beyond significant, unemployment reached 25%, approximately 1 out of 3 banks failed, trade plummeted worldwide, and most asset classes saw tremendous decreases in value. It also led to serious deflation—prices actually dropped 30% from 1930 to 1932. The Great Depression actually went so far as to cause people to lose their belief in capitalism and its long-term viability. The Great Depression also changed a lot more than the economy. This is somewhat similar to how COVID had changed our daily lives, in that it had turned many of us into being OCD about cleanliness, washing hands, wearing masks, etc. These tremendous events tend to weigh heavily on the population and even go as far as to change our mannerisms and sense of being. This is what tends to happen when banks fail.

Can the Great Depression Ever Happen Again?

No probably not. Although the FED has gone on record for saying that the Great Depression is unlikely to ever happen again (Janet Yellen has gone on record saying there will not be anything near to the “Great Recession” in her lifetime), there is always a chance that some unknown exogenous variable could cause something similar to occur. The impact of COVID during 2020 could’ve been very significant but it was handled impressively well. The difference between 2020 and 1930 however is that the FED was much quicker to act in their full capacity with all tools available to them. Back in 2020, in regards to monetary policy, the current FED had stated that they will use every available tool in order to maintain liquid markets—regardless of how it makes the balance sheet look. Moreover, the FED stated that they had become much laxer in regards to the inflationary portion of their dual-mandate. They previously stated they were willing to let inflation rise to “acceptable” levels—past the 2% target rate—so long as it maintains unemployment levels. This could be part of the reason we saw the high bouts of inflation we did in recent years. However, since the high inflation levels of 2022, their stance has thus changed. The FED has raised rates to make sure that pesky inflation doesn’t lead to difficult to eliminate stagflation. Thankfully, since all that has transpired, the FED has appeared to have gotten a better grasp on inflation, however there appears to be more fiscal tailwinds (Trump tariffs, etc.) on the horizon which could put the possibility of stagflation back into play. Even with stagflation, witnessing a re-run of the great depression would be quite unlikely since the economy is setup much differently than it used to be. That doesn’t mean were immune to severe economic contractions but our economy is much more complex than it used to be back then, so the outcome would likely be different.

Cohesive Monetary and Fiscal Policy

With all this being said, monetary policy and fiscal policy work best when they act in unison. So, with all the FED is doing, there is still a possibility that they can no longer artificially maintain the economy if a rebound is nowhere in sight sometime down the road. COVID has undoubtedly changed the world at a stark and brisk pace, but so far, but the reaction has been appropriate by most governments. And AI could do the same to transform the world, as it’s also changed quite a bit in a short amount of time. Still, there are always unknowns and we would never go as far as to say that an economic shock similar to the one experienced during the Great Depression is impossible. If you asked many to predict what 2020 would look like, you might’ve also heard the word impossible, yet the world had drastically changed in a matter of weeks since the onset of the pandemic. However, the chances of it occurring are quite slim. We will see booms and busts, that just a part of our economic cycle and our economic works. The economy expands for a majority of the time but then there are periods of lulls and contraction that also occur. Nonetheless, the odds of a Great Recession and even a Great Depression seem very unlikely. Let's hope it stays that way!