The Great Depression vs COVID 19 Crisis

By Aanya Malaviya, Kunal Malaviya, Khyati Nayak, Sumay McPhail Joseph McPhail.


Many people are asking today, "Are we heading for another Great Depression?"

The short answer is probably not. The COVID19 Crisis caused a massive blow to the world economy. Many millions are out of work. The stock market crashed, and there are a lot of reasons to be concerned. However, the Great Depression was very different. To understand why I will first tell you about the Great Depression. I will then compare the Great Depression to the COVID19 Crisis.

What is the Great Depression?

Great Depression, a worldwide economic downturn that began in 1929 and lasted until about 1939. Although it originated in the United States, the Great Depression caused drastic declines in output, severe unemployment, and acute deflation in almost every country in the world. During this time, many people were out of work, hungry, and homeless. In the cities, people would stand in long lines at soup kitchens to get a bite to eat.

How did it start?

The Roaring 1920s ... sowing the seeds for the Great Depression

After World War I, the economy was doing great. More women began working outside of home. Banks began to give out more loans to as fears from the "Great War" faded and were replaced by optimism. The industrial Revolution created new consumer goods and jobs ushering in an era of spending that was facilitated by borrowing. Soon people were able to buy the latest gadgets, to be exact, most people had a T-Model, Henry Ford 's car.

Americans were becoming more wealthy at the same time that the stock market began to mature. Prior to the 1920s, stocks were considered more like gambling than real investing. Bonds were considered more respectable investments. But marketing and wealth began to change this view. Middle income families began to have more savings, and started looking for new ways to grow their new-found wealth.

Stocks entered a bull market after WWI than led early investors to big returns. Most everyone would like to make money without doing much so what began as prudent investing began to morph into a fear of missing out. This helped drive up popularity in the stock market. Before you know it, people are pouring their money into whatever security is hot that day.

And when they ran out of money to invest...some people started "leveraging". Leverage in this context means to borrow money to invest. People took out loans to invest even more than they had. All this demand led to huge returns in the stock market. By 1929 America's stock wealth doubled, and since 1922 investments had risen by 218 percent.

Stocks were in a bubble by 1929...meaning that prices were well above what could be justified by company earnings and prevailing interest rates. The Federal Reserve, which had only recently been created after the 1907 crisis, tried to slow down speculation by raising interest rates. This had two effects. First, it made leveraged investing more expensive...making it harder for investors to add demand with borrowed money. Second, it made stocks less attractive to own relative to bonds. That was enough to turn the tide of investor sentiment and stock peaked on September 3, 1929.

Greed began to turn into fear. On Thursday, 24 October, 1929, Black Thursday...stocks began to crash. Frightened investors sent the Dow Jones Industrial plunging. Many people who had been building wealth for years had it wiped out within days because leverage magnified losses just as it had magnified gains. The stock market crash is widely regarded as the start of the Great Depression because trading losses sparked the beginning of the vicious cycle downward in consumer spending that would go on for years...ultimately driving the unemployment rate to 20%.

The Great Depression

Source: Crash Course provides this helpful summary of the Great Depression

Makeshift Homeschool wrote another article on "Depressions 101" that I will quote here...

"Depressions are commonly defined as a severe and prolonged downturn in economic activity as measured by gross domestic product (GDP) and elevated unemployment. Depressions are longer and deeper than recessions ... lasting three or more years with a fall in GDP of at least 10 percent within a given year. Employment and asset prices fall and stay lower for longer during depressions. During the Great Depression, the stock market fell 50 percent within just a few months in late 1929. Many believed the correction was over, driving a rebound going into 1930. Evidence of a prolonged fall in corporate earnings had not yet materialized. Prior downturns in 1907 and 1920 had had quick recoveries, creating an anchoring bias toward the recent past. But the initial shock to the stock market set off a chain reaction of bankruptcies that continued to cripple the economy and employment for years to come."

The Great Depression was driven by a deflation. We wrote a separate post on inflation here, but in short, inflation is defined as a general increase in prices and fall in the purchasing value of money. When prices are falling we call that deflation. The Great Depression is the classic example of how deflation can cause horrible economic damage. When stocks crashed many people lost their savings and people stopped spending as much. In order to sell goods companies had to lower prices of their products. But, then they would make less money from selling the goods, forcing them to lower wages or lay even more people off. With even MORE people unemployed, they were not able to buy as many goods causing prices to drop lower and lower, while the unemployment rate shot higher and higher. Leading us into this giant downward cycle of deflation and unemployment.

The deflationary spiral was allowed to worsen through 1933 in large part because governments and central banks had not learned ways to help. The US Federal government was quite small during the 1920s, amounting to under 4% of GDP compared to over 20% during the Financial Crisis. The drop in consumer spending left a huge hole in demand that only the Government could fill given their control over the money supply.

Herbert Hoover was President of the United States when the Great Depression began. The economy had experienced recessions before and recovered without government assistance, and so he was slow to act. The Federal Government had simply never been used to try to reduce the severity of recession. But over time, it became clear that something was different about the Great Depression. People began to blame Hoover’s inaction for the Great Depression. They even named the shantytowns where homeless people lived "Hoovervilles". Economic hardship was worsened by uncontrollable factors like farmers struggling in the Midwest where a great drought turned the soil into dust causing huge dust storms, deepening the crisis further.

Several factors that made the Great Depression worst than prior recessions. These factors ushered in a new era in which governments would begin taking a more prominent role in attempting to prevent and dampen the effects of recession. One was the expansion of consumer credit following the Industrial Revolution, which put banks at the center of the implosion.

Bank Failures

A big reason why the Great Depression was so massive was widespread bank failures. Banks had made lots of loans to people and businesses, but fewer were making payments. Deflation made incomes lower so there wasn't enough money to pay the banks. Many loans were also backed by land, buildings, and other collateral that was losing value because of deflation making bank defaults more costly.

Unlike today, banks were not insured by the Federal Deposit Insurance Corporation (FDIC). Today, when a bank fails, the FDIC pays people back for savings lost up to $250,000. But during the Great Depression, bank failures usually meant that you lost all your savings. Fear of bank failures were massive. Rumors started bank runs frequently. That is why the children in the Movie Marry Poppins could start a stampede to redeem deposits by simple yelling "give me back my money".

Banks don't carry enough money to redeem all deposits. They take deposits and use them to make loans. This scene from "It's a Wonderful Life" illustrates this. The town was worried that the bank did not have enough money. And that was true! George explains this "factional banking system" better than I can in this classic scene. He basically says the bank only holds a fraction of deposits because it uses the rest to make loans to people who want to buy homes, farms, and start businesses.

The fractional banking system created a massive fragility that was exposed by the Great Depression. At the peak of the Great Depression, 4,000 banks wen't belly up in one year, 1933, just before the New Deal which included the first FDIC insurance program, but only after millions had lost their life savings.

The New Deal

Finally, in 1933, Franklin D. Roosevelt was elected president. He promised the people of America a "New Deal” to overcome the Great Depression. The New Deal was a series of laws enacted and agencies established to help the country deal with the Great Depression. These laws placed regulations on the stock market, banks, and businesses.

The various impacts of these regulations are complex, but the net effect was clearly positive. Unemployment peaked shortly after the New Deal was enacted. Government spending offset the drop in consumer spending enough to stop the deflationary cycle. This helped prop up prices which helped put people to work. Assistance for the poor was also expanded. Many of these laws are still in place today like the Social Security Act, child labor laws, and federal minimum wage laws.

Establishment of FDIC was a huge part of the New Deal. As discussed earlier, widespread bank failures were a huge contributor to the Great Depression. People lost the money they had deposited in the banks as there was no insurance for the money saved!

The Great Depression shows the important roles that money, banks, and the stock market play in our economy. The Great Depression also brought us the Federal Deposit Insurance Corp (FDIC), regulation of securities markets, the birth of the Social Security System and the first national minimum wage. Today, many of these new policies and regulations are still in place today and still the subject of debate.

Another recession occurred in 1937, but this was more a function of the Federal Reserve than a failure of the New Deal. The Federal Reserve was worried that the recovering stock market was being driven by another speculative bubble. In order to prevent another bubble they raised interest rates which hurt consumer spending just as it was recovering. But unemployment was already well off the 25% highs in 1932.

The Great Depression officially ended in 1939 in large part because of WWII. While the USA did not officially enter the war until December 7, 1941 ... the USA benefited tremendously from selling equipment and extending credit to the allied powers, especially France and England. Government spending ramped up to assist the war effort leading to the most rapid expansion in GDP in USA history. The wartime economy put many people back to work and filled factories to capacity.

Comparison with COVID-19 Crisis

With the global economy still in partial shutdown, a lot of people are asking if we are headed for another Great Depression. But there are many differences. The causes, strength of our financial system, and policy response are totally different. I share these key differences below before discussing the unique challenge we face with COVID19.

Key differences between COVID19 and the Great Depression

The cause of the Great Depression was a stock market bubble supported in part by leverage. Stocks were new to many people, and many got so caught up in speculation that they borrowed money to support buying. This created a large shock when stocks inevitably fell. In contrast, COVID19 was a pandemic that hit when the economy was more or less strong. There was no obvious speculative bubble in stocks driven by leveraged borrowing. The virus forced a temporary shutdown of much of the world's economy which will continue to struggle until we get a vaccine, but there is good reason to think that we can get back to normal by the end of 2021. This timeline is supported by a different historical example from more than a decade before the Great Depression: the 1918 Spanish Flu pandemic, after which the U.S. economy bounced back relatively quickly. They used similar social distancing measures and eventually the economy got better.

The financial system is far stronger today than it was during the start of the Great Depression. The most critical difference is FDIC insurance. Massive bank failures wiped out millions of family savings accounts during the Great Depression. That did not happen and will not happen not because bank accounts are insured up to $250,000. We don't need to worry about losing our life savings from a bank run, or the knock-on effects that such events would have on the broader economy.

The policy response has also been quite different. The Great Depression dragged into a deflationary cycle of falling prices and rising unemployment in part because The Federal Reserve and Federal Government did not know how to help. The Federal Reserve had only been around since late 1913, with no real experience in handling the fallout of a speculative bubble. The Federal Government was also much smaller then ... and the culture at the time was less supportive of a strong Federal Government response. But as the Great Depression dragged on public opinion changed. In contrast, the policy response to COVID19 has been large and fast. Deflationary pressures from job losses and fear have been at least partially offset by a lot of federal support which should help to avoid some of the downward spiral that made the Great Depression so hard for so many.

That said...COVID19 presents real challenges of its own.

The COVID19 Challenge ... managing all the debt

Globally we have never had as much debt as we do today relative to the economy. This was true before COVID19, but debt has grown even more since. This includes government, business, and household debt. The size of global debt is a problem because a large chunk of it is dependent on very low to zero interest rates. This has led to increasingly risky investments and a dependence on debt financed consumer spending.

The size of the debt may not seem like a problem because it is still largely being "serviced". In other words, governments, businesses and households were generally paying their debts. Low and negative rates allowed for higher debt...and if rates stay low for a long time then theoretically today's high debt levels should be a manageable problem. But COVID19 illustrated the fragility caused by the large debt build up.

Central banks had a choice. They could have let heavily indebted businesses fail and get forced into bankruptcy, or they could backstop these markets and allow debts to grow even larger. Just about every central bank around the world opted to backstop these markets believing that allowing mass defaults would send us into a global depression, and they were probably right. As a result...the world's debt markets are more dependent on central banks than ever before. Unlike in January...most prices are being directly pushed by central bank actions.

The longer this goes on the longer the global economy becomes dependent on artificially low interest rates. Many governments need artificially low rates to fund deficit spending. Many businesses need artificially low rates to refinance. Many households need artificially low rates to commit to buying a house or car given all the uncertainty.

In short, the debt is a problem because it is becoming increasingly dependent on artificially low interest rates...and if rates rise then large swaths of the economy may default at the same time. Such a scenario could cause a deep recession on the scale of the Great Depression, but such a scenario is not guaranteed or even likely.


COVID19 Crisis was the biggest hit to the USA and global economy in 50 years. The unemployment rate jumped from its lowest point to its highest point in just two months. Such a massive shock has justifiably made a lot of people nervous and so it is not surprising that many are asking if we are headed for another Great Depression. But there are many differences between the challenges faced today compared to 1929. The two are qualitatively different so we should not jump to conclusions that we will repeat the past.

Thank you for your interest!


About the lead author...

Aanya eleven years old, friend of the McPhails, and core contributor to many WEquil initiatives including Makeshift Homeschool and Evolutionomics. Aanya also has her own blog called "Politics and Clicks" where she shares thoughts on her favorite subjects like politics, food, and history.