Everywhere I go people are discussing the fallout of the economy, whether it is taxicab drivers, flight attendants, pilots, farmers or lenders. One lady, age 72, on a redeye flight in the seat behind me chose to invest all her money in gold. I only hope it was not with someone like Bernie Madoff. Others are asking more questions about a possible depression. It is time to examine the subject of economic depressions to put this economic variable into context.
First, let’s define a depression. It is defined as a decline in per-person GDP or consumption by 10% or more. Two depressions have occurred in the U.S. since 1870. The Great Depression from 1929 to 1933 showed a macroeconomic decline of 25%. Another depression was post-World War I from 1917 to 1921, with a 16% decline. GDP for the last quarter of 2008 was revised down to negative 6.2%.
Since 1870, there have been 97 depressions worldwide. For example, after World War II there was the Latin American debt crisis of the 1980s, Finland’s crisis in the early 1990s, Mexico’s financial crisis in the mid-1990s and the Asian financial crisis of the late 1990s.
Since 1870, there have been 251 stock market crashes worldwide, when cumulative real returns are negative 25% or less. For example, in the Great Depression in the U.S., the market was down 55% between 1929 and 1931. In Finland from 1989 to 1991, the market was down 47%.
- There is a 92% probability that a major depression (25% or more decline in GDP) will have a stock market crash of 25% or more.
- There is only a 9% chance that a major depression (25% or more decline in GDP) will occur when there is a stock market crash. For example, the U.S. had a stock market crash in 2000-2002 of 42% and in 1973-1974 of 49%, but they only resulted in recessions.
Recently the U.S stock market has crashed by 50+%. Only time will tell whether the “big one” will occur.