- Education and Science»
Recessions vs Depressions
You could ask a hundred different economists the difference between a depression and a recession and you would receive a hundred different answers. But, they would all agree that a recession and a depression are defined as a decrease in gross domestic product, and that a depression is an intensified and elongated recession.
There is no set of rules that dictate when a recession transitions over to a depression and more interestingly, sense the great depression of 1929, there has been no other recession to progress to a depression. Recessions are two straight quarters of reduction in gross domestic product. Since no one has a set rule, everyone has an opinion of what that transition might be. Some of those include, 3 straight years of negative gross domestic product, a 10% or higher drop in gross domestic product, a 10% or higher unemployment, a recession that does not self-correct, and lastly an economic situation that requires normal citizens to sell tangible assets to stay afloat. A depression could be a combination of these, and or also include other factors. One of the best ways to be precognitive to the onslaught of a depression is to look for correlations to past experiences.
We currently don’t have 3 years of negative gross domestic product, a 10% or higher drop in gross domestic product, or 10% or higher unemployment, but few will disagree that this recession has not had a self-correction. In other words government has attempted to step in to bring us out. Many people have had to sell tangible assets (like jewelry, TVs, etc.) to get some extra income, but it isn't as bad as it could be. I wish I could say we aren't heading towards a depression based on these criteria, but there have been no significant signs to indicate recovery, yet.
The Great Depression is commonly used as an example of how far the world's economy can decline. So it is no surprise that this point would be a reference to correlate our current situation. The depression originated in the United States, after the fall in stock prices that began around September 4, 1929, and became worldwide news with the stock market crash of October 29, 1929 also known as Black Tuesday. Fundamentally speaking, the roaring 1920s was fuelled by excessive lending to unqualified borrowers from banks, and excessive speculation money in the market. When those speculations didn't pan out the unqualified borrowers didn't have the means to supplement the necessary income to compensate for lack of currency in the market. Ultimately resulting in a domino effect on the economy that resulted in a 25% unemployment,
Alternately in the early 2000s, just as there was in the 1920s, there was an increase in the lending to unqualified borrowers from banks. But instead of an excess of speculative money, there was an increase in amount of currency in the market with no increase in the principle, meaning that our currency has been devalued. From that standpoint there is no growth of gross domestic product, just a rise in individuals afflicted with money illusion.
Money illusion is reacting to an increase in the currency cost of an item or service rather than its core value. In this instance the more money our government prints, the more devalued the United States dollar becomes, and the more Americans fall for money illusion. When you have paper currency based on valuable metal you can only print as much currency as the quantity of the valuable metal will sustain in the world market. So when the government prints more money, comparatively we don't gain any value, only our amount of currency inflates but is thinned. For instants if I have 100 grams worth of gold backing $100 of paper the true value per dollar is 1 gram of gold, but if I print $100 more of paper without adding to my gold, I have made the true value of my paper dollar .5 grams of gold. In summation when money is not sustained by something of value, then the worth of the money is based on the faith of the people in the government. When it becomes obvious to the people that their money is worthless a financial collapse will occur, but until then they are suffering from money illusion.
This is more destructive because these individuals will not change their spending habits because they will have the inability to recognize the dexterity of the economic situation.
Although the numbers from the great depression are exponentially larger when it comes to deficit, there is a good lesson that can be pulled from observing the correlations between current events and the past. The very reason that we learn our history is so that we do not repeat it. I cannot tell you when a recession transitions into a depression, but what I can say is that there are many similarities between what happened leading up to the great depression, and what is happening right now.