The Most Important Difference Between the Great Depression and Where We Are Going Now

by Michael Lombardi, CFP

On November 14, 1929, the stock market crashed. Then, in early 1930, the stock market started to rally and, by April 1930, the stock market had regained 50% of its losses. The biggest question these days: is history about to repeat itself?

Yes, I do believe history will repeat itself. As I have written many times in this column, we are in a bear market rally that will sucker investors back into the market before the bear brings stocks back down. I base this theory on the fact that bull markets end at a very speculative point when stocks are severely overvalued and bear markets end when stocks become great bargains. We have not yet reached the point in this cycle where stocks became great bargains.

However, while I do see history repeating itself in terms of a bear market trap occurring today very similar to what happened in 1929-1930, my thoughts about us entering a new Great Depression era are very different.

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There are big differences between the severe recession we are experiencing today and the Great Depression. But there is one core difference that makes the likelihood of another Depression only a remote possibility: the Federal Deposit Insurance Corporation (FDIC).

During the Great Depression 10,000 banks failed. Yes, that is 10,000. Imagine depositors losing their money, imagine the shareholders losing theirs. Depositors, in fear of losing their deposits, could not get their cash out of banks fast enough, creating a run on the banks. The FDIC was not established until 1933 and insurance for depositors’ monies was not started until January 1, 1934 — too late for many. The Banking Act of 1935 established the FDIC as a permanent agency of the government, with deposit insurance of up to $5,000.

Since the credit crisis began, fewer than 20 American banks have failed. And today the FDIC insures up to $250,000 per consumer deposit per financial institution. Those that make an erroneous comparison to the events of today leading to another Great Depression fail to realize the instability of the banking system (and the protection of its depositors) in the late 1920s and early 1930s. That’s the most important difference between the Great Depression and where we are going now and why the Great Depression, Part II, is so highly unlikely.

Michael’s Personal Notes:

This rally has stock market gurus really going, resulting in many forecasters revising their stock predictions higher. Marc Faber, who writes the “Gloom, Boom and Doom Report,” now says the S&P 500 will rise to 1,000 (which is 17% higher than where it sits today) within the next three months. Faber is right. The S&P 500 will move higher. But where the two of us diverge is on our opinion on where the market goes after the current rally. Faber says the S&P 500 lows of March 6, 2009, will hold and that we will have higher stock prices in July. I don’t believe the March 6, 2009, lows will hold. I believe they will eventually be tested again.

Where the Stock Market Stands:

The Dow Jones Industrial Average was flat yesterday. In my mind, the index is looking for any good news as a cause for more rallying. It was impressive though that the market didn’t give back any of the previous week’s big gains. Jim Rogers warned investors Monday that they should expect more bottoms and I agree with him. But why not enjoy the market rally while it lasts? The Dow Jones is down about eight percent for the year.

What He Said:

“The Real Threat to the Economy: U.S. retail sales are falling, the producer price index is crashing, house prices, car prices are all falling — and no one is talking about deflation but me. Fed governors are still talking about inflation — they’ve got it wrong. There’s no need for me to get into the dangers of deflation, as I’ve written about them (many times) before. Let’s just put it this way: Deflation is about the worst economic state a country will experience. The risks to the U.S. economy in 2007 are greater than I’ve seen in years.” Michael Lombardi in PROFIT CONFIDENTIAL, November 15, 2006. Michael was one of the first to warn of deflation. By late 2008, world economies were embedded in their worst state of deflation since the Great Depression.