What Causes an Economic Depression?

  • Thread starter CaptainDan
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Aug 2, 2020
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It's really not a complex concept. If we compare the national or global economies to a very localized one or even an individual's finances, things become clear rather quickly.

Let's say that you're living in a time when a pack of bubble gum costs $1. You're a kid, so your primary job is mowing neighbors' lawns and shoveling their snow. Because you earn so much money doing these things, you're able to buy a lot of bubble gum. The more you buy, the greater the demand for the gum, the higher the prices go. This type of thing is healthy (in moderation) for a well functioning economy. Now let's say that, for whatever reason, half of your customers don't want you to do their work for them anymore. Because of this, you only earn half the money you used to. Because you're not earning that much, you don't buy that much gum. And because of that, the price of gum stays stagnant. And because of that, the guy who sells the gum (your neighbor) stops paying you for mowing his lawn. And because of that, you can't buy any gum at all, causing a massive price drop. And because of that fall in gum prices, the guy who sells it is forced out of business, compounding the problem all over the place. You get the idea. Depressions spiral down and get worse and worse as more people are affected by them. Essentially, depressions are caused by falling prices (deflation), which are really just a symptom of a contracting money supply.

Do you remember the economic crisis of 2008? Do you remember when Fed Chairman Ben Bernanke said that the problem with the depression in the 1930s was a lack of money supply. In the 2000s, he injected so much money into the world economy that he earned himself the name of Helicopter Ben, because it was like he was dumping money from a helicopter. The run up in the stock market for the past ten years has been partly because of this money dumping. Hint, hint - today's money supply expansion puts the one from 12 years ago to shame. Should you invest in stocks today? Yeah, I think so.

Anyway, the way money is created in the first place is for an individual, couple, or an organization (a business, state, or a country) to take a loan from a bank. That loan creates new money. I know, it's tough to wrap your head around. Let me put it this way. If there were only two people in the world and between them, they had $100, there would be just $100 in the world economy. Let's pretend that one of those people walked up to the other one and said that he would like to borrow another $100. If the first person turned around and somehow printed that second $100 and gave it to the second, there would then be $200 in the world's economy. Really, that's how it's done. It's that simple.

Now, let's continue on using the two person example. Let's say that one of the people in this story starts to get nervous because of some sort of economic unrest. Perhaps he's having trouble getting supplies to make his products or something else like that. Because of this nervousness, he takes his portion of the money and hides it under his mattress. Because this money is being saved or hidden, or whatever you want to call it, it essentially shrinks the available money supply in the entire world. If both people were to get nervous and do this, the available money supply would dwindle to nothing. That would cause real problems.

Now, I want you to notice how I used the word available in the previous paragraph. Money that's sitting in people's bank accounts and not being spent is useless to an economy. One of the things that makes recessions and depressions worse than they need to be is the hoarding of cash. Individuals and businesses do this when they become concerned. Actually, right now in the world, corporations large and small are sitting on piles of cash sitting in their bank accounts. It's not having money that helps an economy, it's the spending of money that does. It's the velocity of the money that flows through an economy that helps things along.

If the Federal Reserve printed $100,000,000,000,000,000 right now and then parked all that money in an account somewhere and did nothing with it, would it have any effect on the national or global economy? Nope. Not at all. Now, if they printed all that money and gave it to the poorest of the poor around the world, would it have an impact? Absolutely. Those poor people would spend it immediately and prices would go through the roof for the products they like to buy. There would be so much competition to buy certain things that bubbles would form and there would be an entirely new set of problems. Sort of like when people try to buy snow shovels during a snow storm. We've all seen how that turns out. But you see how it works. Money that doesn't move doesn't help an economy. It's the money that moves that does. This is why governments like to offer stimulus payments only to people who earn less than a certain amount per year. The governments know these people will spend it and that's what they want. Well off people don't spend their money; they save it. And that's useless when it comes to sparking an economy back to life.

A lot of people wonder if money can just go away. If it can evaporate. The answer to this is yes, it can. Money can simply disappear. The times we're living through right now are a perfect example of that. I'll explain. Because of COVID-19, many people can't pay their rent in apartment buildings. Because of this, they're asked to move out. After they move out, no one else can move in because so many people are losing their jobs. These new people can't afford the rent. Since there are no new renters, landlords are forced to reduce the rent they seek. Because of this, some new tenants move in. The landlords are now operating businesses that are not making nearly as much as they used to. If they tried to sell the buildings, they'd only get a fraction of what they would have gotten if there was no pandemic and if no one was losing their jobs. So if the buyer of the building took a loan for the purchase, it would be smaller than otherwise. Take this example and spread it over all aspects of the economy and you'll see how dramatic it can become. It's for this very reason that governments all over the place are giving people stimulus checks. So the money supply around the world doesn't contract. If no stimulus was given, a deflationary effect would spiral out of control and there would surely be a depression as a result.

On the face of it, economic stimulus seems like a great idea during recession and depression. The questions that begs to be asked is, are there any negative effects? The answer to that is a resounding yes. First and foremost, the money for economic stimulus comes from the Federal Reserve, which is a privately owned bank. It's loaned to the United States government at interest. As this happens, the national debt grows. And grows. And grows. We all know what happens when debt grows to the point of being unmanageable. I don't even want to think about that. Collapses of governments happen, that's what.

Second, with the influx of money, the economy begins to look good again. There's a renewed confidence, which creates spending. Because of the confidence, all the people and businesses who were hoarding their cash begin to pull it out of their accounts to spend it. That's a lot of money on top of the stimulus and regular gyrations of the already existing economy. The increased spending creates bubbles and inflation. If there's too much money supply released into the economy, something called hyper-inflation is introduced, where people begin to lose faith in their currency. That's when currencies collapse, which is akin to a collapse caused by debt.

As you can see, dealing with currency introduction during recession or depression requires a delicate balance. Too much or not enough can be devastating. No matter how you look at it, reacting to these types of things is rarely good, so avoiding them is better all around. The debates that arise are centered around how to avoid them, but that's a post for another day.

This post is part of a series: Guide to Investing in Gold & Silver by Michael Maloney
What Causes an Economic Depression? was posted on 06-03-2021 by CaptainDan in the Economics Forum forum.

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