As the world grapples with the biggest slowdown since the Great Depression we’re hearing the word ‘depression’ in the media more than ever, certainly more than we have in the last decade. While a definition of a recession is widely known, a definition of a depression is harder to come by.
So what is a depression? Why are we not headed towards one? And what would be the danger signals to watch out for?
A technical recession is two consecutive negative quarters of GDP (Gross Domestic Product).
A depression is used to describe a situation where GDP falls by more than 10%. A depression can be thought of as a prolonged and sustained recession. This is usually also associated with a bursting of credit and/or asset bubbles and deflation.
Deflation is something that hasn’t received much attention. Scarier than the prospect of inflation is the prospect of deflation. If inflation refers to prices rising, then deflation refers to prices falling. But if you are a keen shopper, you may ask yourself “Why is it bad if prices fall, surely lower prices are a good thing?”
Prices falling may be good news for the astute shopper but it is bad news for the economy. The problem is twofold:
The last depression in Australia was the Great Depression in the 1930s. Unemployment peaked at 29% in 1932 and GDP declined by 10% between 1929 and 1931. At a conference in 1930, state and federal government agreed to slash spending in what became known as the Melbourne agreement.
Australia has learnt from its mistakes and in this slowdown we are seeing an increase in government spending.
What the world needs is to take action and try to make sure that the slowdown is not long and protracted. A recession is usually combated through monetary policy through lower interest rates. Fiscal policy tends to be less effective because it takes longer to see the benefits.
On the other hand, in a depression where there are falling asset prices and deflation, interest rates are less powerful than fiscal policy.
Remember that the bottom of the market is usually seen when investors are too scared to invest. Keep an eye out for opportunities. After all, much of a profit can be attributed to when you buy not only when you sell.
Happy trading!
Julia Lee Equities Analyst Bell Direct
Have you started trading with Bell Direct for just $15 a trade? Register now for free.