A depression is a nationwide decline in production that is the result of capital mal-investments into unprofitable industries.
Mal-investments can occur in a free-market, but not to the scale or extent as they do today, as speculation is limited to using real assets (as collateral). The economy crippling, nationwide cycles of “booms” followed by “busts” are the result of the only agency that has the power to act on a nationwide scale: the government.
These capital mal-investments can occur on such a large nationwide scale only by the government over-riding the checks and balances provided by the market.
In regards to the banking sector, one example is the policy of making money “cheap” (having banks lower the rate of interest below market “natural” levels) by “expanding the money supply.” This “cheap” money results in over-investment into industries that would appear unprofitable if the government did not intervene in the money supply. Once these mal-investments are discovered, the result is a bust (depression) as the market begins the process of recovering from these mal-investments of capital.
To prevent great nationwide depressions the government needs to keep its hands off the money supply, by establishing a free-market for money (free banking).