The cause of the Great Depression in the 1930s, and the Great Recession beginning in 2007, was one and the same: an overleveraged economy. Excessive debt levels are the direct result of the central bank providing artificially low interest rates and of superfluous lending on the part of commercial banks.
The easy money provided by banks eventually brings debt in the economy to an unsustainable level. At that point, the only real and viable solution is for the public and private sectors to undergo a protracted period of deleveraging. The ensuing depression is, in actuality, the healing process at work, which is marked by the selling of assets and the paying down of debt.
Unfortunately, our politicians today are focused on fighting this natural healing process by promoting the accumulation of more debt.
During this latest economic contraction, the Federal Reserve took interest rates to near 0%, and the Obama administration is leveraging up the public sector to record levels in a bid to re-leverage the private sector. The government's philosophy is tantamount to sticking a frostbitten man in the freezer so he won't have to suffer the pain associated with the thawing of his extremities.
During the Great Depression, real gross domestic product plummeted 32%. The Great Recession, which we are still struggling through, began in December 2007, according to the National Bureau of Economic Research. In contrast to the 1930s, GDP during this recession shrank only 3.6% from the fourth quarter of 2007 through its low point in the second quarter of 2009. Between the fourth quarter of 2007 and the first quarter of this year (the most recent period for which data is available), GDP contracted a mere 1.1%.
The contraction in GDP during the Great Depression was the direct result of consumers paying down debt and selling off assets. Household debt as a percentage of GDP reached nearly 100% in 1929. To put that number in perspective, household debt did not go back above 50% of GDP until 1985. It was not until the first quarter of 2009 that household debt once again approached the Great Depression level of 100% of GDP.
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