The best economics book I've read is Benjamin Roth's diary, which he kept during the Great Depression. Roth, a lawyer with no formal investing or economics background, gives an incredible account of how normal people thought about the depression and the collapsing stock market.

Roth wrote extensively about similarities between the depression of 1930s and the financial panics of 1837, 1873, and 1893. "I am struck by the similarities," he wrote in 1933. The way people reacted, the emotions they felt, and the things they feared during previous panics seemed to mimic the Great Depression.

Reading Roth's diary recently, I realized that most of what he wrote about in the 1930s is also nearly identical to the kind of stuff we experienced around the 2008 financial crisis. 

Here's Roth in 1932, wondering why the stock market began surging even as the economy was in shambles:

The month of August just ended has been the lowest point so far in the depression for all kinds of business and professional men. The stock market on the contrary tripled its value during August in one of the quickest climbs ever witnessed. I believe this also established a record. Nobody seems to know even yet why the stock market went up because business has gotten worse instead of better.

This same attitude prevailed in 2009, when the economy was a mess but stocks boomed. That trend can be perfectly normal: There's almost no correlation between what the economy is doing today and what the stock market might do tomorrow. Economic data looks backward, at how many jobs were created last month, while the stock market looks forward, at how many jobs we might create over the next year or two.

Here's Roth in 1933, writing about contempt for bankers:

Again and again dishonesty and speculation by bankers with bank funds becomes the subject of newspaper notoriety. The latest investigation discloses such practices on part of National City Bank of New York. By manipulation the officers boosted and unloaded on the public their own stock in National City Bank to the public as high as $650 per share when its book value was only $60. Likewise when the crash came this same bank sold out collateral of its customers but loaned money to its officers to save them from loss. Other similar practices enriched the bank officials at the expense of the depositors and the public.

You could change about five words in this paragraph and make it look identical to a 2010 article written about Wall Street.

Here's Roth in 1936, concerned about money printing, inflation, and deficits:

People think if more money were printed business would be better. This is a false and vicious theory ... I am personally very much concerned with the question of inflation and it seems to me there is a grave possibility it will come unless the government at once balances its budget. With an election coming this seems out of the question. Every year since Roosevelt took office has seen us deeper in debt. We now owe $35 billion and 1936 seems to promise more spending than ever because it is an election year.

This same fear of imminent inflation has been with us for the last five years. In both cases the fear was misplaced, not realizing that deflation is by far the larger risk when you're in a debt deleveraging.

Here's Roth in 1933 explaining boom-bust psychology:

In 1928 people were excited about big profits on the stock market: they read literature about investments, lived high and talked about the "new era." Today their outlook is gloomy, they think the depression will never end, the stock market is an abomination, real estate is no good, everybody is cynical, etc ... The slump is now looked upon as of indefinite duration ... Just as the public was mistaken in its excessive optimism of 1928 I believe it is mistaken in its excessive gloom.

This could have been written in 2009. In hindsight people are amazed at how irrationally optimistic investors are at the top of a bubble, but herd-mentality pessimism can be just as shocking – and just as dangerous.

Here's Roth in 1931 discussing fears that technology would eliminate everyone's job:

There is also considerable discussion about the new science of "technography" which holds that new machinery and electricity have replaced many men in industry who will never find a job again. I am confident that new inventions and scientific discoveries will remedy this situation.

This has been a big fear in recent years. Farm hands in 1930 were the manufacturing workers of 2010. We've actually been worried about this for centuries. In each case a group of workers finds it hard to find work after an industry implodes, but, on net, the economy eventually finds enough work for everyone.

Here's Roth in 1936 about the difficulty of timing the market:

Most people do not have the patience to wait for the bad break. The average speculator is tied up in the market to the hilt when the break comes and has no liquid cash for the bargains that prevail. In 1932 with stock prices at 10% of normal he could not have gone far wrong in buying stocks with 20 or 30 years earnings record and with a good chance to survive the depression. However, not one man in a million succeeded in doing this and that is why the millionaires club is still exclusive.

Eighty years later, this is why bankruptcies outnumber billionaires.

In 1939, Roth looked back on a decade of expert predictions about the depression:

As I reread some of the predictions made by outstanding economists in past few years, I must laugh. They were all wrong. None of them foresaw the 1937-39 collapses and many predicted inflation before this ... Those offering predictions for the future or even detailed readings of the present are often wrong because of incomplete information, flawed statistical models, or hidden agendas ... During the past depression prominent bankers, business men, etc. were all wrong in most of their predictions. Use your own judgment and do your own thinking.

That is timeless advice.

Finally, here's Roth near the end of his diary:

Business will always come back. It will remain neither depressed nor exalted.

Same as it ever was.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics. 

For more:

Performance vs. outcomes

Why does pessimism sound so smart?

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Hard truths for investors to wrap their heads around

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