Economic depression vs recession: how to prepare for financial downturns

Downward trend
Rebecca Cattlin
By :  ,  Financial Writer

An economic depression is more severe and long-lasting than a recession, but both can wreak havoc on financial markets. Find out what the difference between a depression and recession is, and how you can prepare for a longer economic decline.

 

Economic depression vs recession

A depression and recession are both periods of economic contraction, the difference between the two is the duration and severity of the event.

A recession is typically defined by statistics agencies as two consecutive quarters of declining gross domestic product, normally lasting for a few months. Meanwhile, a depression is more extreme and lasts for years.

Learn more about how to trade a recession.

 

Depression vs recession: the difference in numbers

 

 

The Great Recession

The Great Depression

Duration

2007 to 2009 (two years)

1929 to 1939 (10 years)

Unemployment

10.6%

24.9%

GDP

-4.3%

-30%

 

What is an economic depression?

An economic depression is an extreme decline in economic activity – usually lasting several years or even decades. Although, there’s no clear moment or threshold at which a recession becomes a depression.

There’s no strict definition of a depression, where economists say the unemployment rate hit X level or GDP growth hit X level. That’s because there’s only been one economic depression in recent history – the Great Depression that ran from 1929 to 1939 in the US.

 

How long do economic depressions last?

Economic depressions can last varying amounts of time – from years to decades. As there’s only been one depression in recent history there isn’t enough data to look at.

While some economists would say a depression only lasts as long as the decline in economic activity, others would say that the depression lasts until the economy returns to normal levels.

What causes an economic depression?

An economic depression has no single cause but is the culmination of falling consumer confidence and demand to the point that companies have to cut costs – which leads to rising unemployment.

In the case of the Great Depression, the decline started in 1929 in the form of a recession and stock market crash. The economy had already been trending downward for a year, which had left stocks overvalued – triggering a mass sell-off.

The stock market crash showed consumers their fears were justified – leading to even lower levels of confidence, spending and investing. A huge number of businesses and banks failed which increased unemployment. Then a severe drought known as the Dust Bowl hit and the economic rout continued for 10 years.

 

What happens to stocks in a depression?              

In a depression, the stock market is one of the first places that feels the growing pressure of unemployment and low consumer confidence. As investors rush in to sell their positions in failing businesses, it forces share prices down lower and lower.

In the Great Depression, investors sold approximately 13 million shares in an event that became known as ‘Black Thursday’ on October 24 1929. The crash’s bottom wasn’t reached until July 9 1932, at which point the Dow had fallen by 89.2% in total – from 381.17 down to 41.22.

Very few companies survived the Great Depression, but it’s unsurprising that those that did fall into the ‘defensive stock’ category. Most were food companies, energy and utilities firms, manufacturers and retailers, who provided essential goods and services throughout the downturn.

Learn more about stock market crashes.

How to survive an economic depression

Surviving an economic depression all comes down to preparation. You can protect your existing positions with risk management measures, and any new positions entered should always be thoroughly researched.

One of the most common strategies in a downturn is diversification – making sure that all your trades aren’t in one industry, asset class or country.

But it’s also important to assess your overall capital allocation. Managing your account balance is important at any time when you trade on leverage, but in a depression, your risk appetite might have to change.

You can go long or short on financial markets with derivative products, enabling you to speculate on both rising and falling financial markets.

You can start by opening an account, or practise first in a risk-free demo account

Is an economic depression coming?

It’s highly unlikely that an economic depression is coming. Although experts are warning of a recession in late 2022 and into 2023, it’s expected to be mild. Unlike the 2008 financial crisis and the Great Depression, financial institutions haven’t been as badly affected, so the damage could well be limited.

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