The Rhetorical Significance of the 1920-1921 Depression

The Rhetorical Significance of the 1920-1921 Depression
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Jim Grant has a new book out on the 1920-1921 depression in the United States, and the relevance it has for macro policy. (HereWarren_G._Harding you can listen to Tom Woods interview Grant about the book.) Because of Grant’s book, mainstream commentators are picking up on the episode, though in all immodesty I just want to point out that Tom Woods and I (independently) were discussing this years ago.

In any event, Paul Krugman can’t believe he has to deal with these idiots, when he’s already blown up the claims that the 1920-1921 depression has anything to teach us. He writes today:

Two things to say about the bizarre citation of the 1921 economic recovery as somehow refuting everything we’ve learned about macroeconomics since then. First, we’ve already been over this, here and here. The 1921 thing is of no use precisely because it looks like the kinds of recession where the Fed creates a slump with tight money, then relents; the whole point about 2007 onwards — predicted in advance — is that it was a postmodern recession caused by private-sector overreach, and therefore much harder to end. Anyone trotting out 1921 at this late date, with no reference to the discussion we’ve already had on the subject, is just lazy.

Second, there is a familiar phenomenon here, in which a certain kind of would-be economic expert loves to cite the supposed lessons of economic experiences that are in the distant past, and where we actually have only a faint grasp of what really happened. Harding 1921 “works” only because people don’t know much about it; you have to navigate through some fairly obscure sources to figure out that it’s a tight-money recession that ended when the Fed reversed course.

I’ll let Tom and others deal with Krugman et al.’s pushback on their own terms, if they wish. (The true scholar should go read Daniel Kuehn’s critique of us as well.) But let me explain why I got interested in the 1920-1921 episode, and how Krugman’s response above misses the mark.

What happened in my case is that (in the winter of 2008/09) I was doing research for my book The Politically Incorrect Guide to the Great Depression and the New Deal. I was going through the common arguments for why the 1930s depression was so awful, and I eventually realized that all of the main reasons you typically hear–often from both Keynesians and Chicago School monetarists–made no sense, because things were much much worse in each of these dimensions in 1920-1921.

Specifically, the Keynesians will say that Herbert Hoover didn’t increase federal spending enough. Monetarists will say that the Fed didn’t ease sufficiently. And both camps will say that the crushing deflation, in combination with sticky wages, led to a downward spiral in spending that caused unemployment to reach record highs.

So in reaction to those types of claims–which remember, are supposed to show us why the 1930s mushroomed into the Great Depression, yielding a decade of despair–I pointed out that in the previous depression of 1920-21:

==> Far from boosting spending, the federal government (under Wilson/Harding) slashed spending 82 percent over three years (that’s not a typo), going from $18.5 billion in Fiscal Year 1919 to $3.3 billion in FY 1922.

==> Far from easing, the Fed engaged in literally unprecedented tightening, with discount rates rising to all-time highs (since the founding of the Fed) and with the monetary base collapsing some 15 percent year/year (though that’s using the seasonally adjusted data, so some may quibble with the figure).

==> Prices fell more rapidly in one year than at any 12-month span during the Great Depression. From its peak in June 1920 the Consumer Price Index fell 15.8 percent over the next 12 months. In contrast, year-over-year price deflation never even reached 11 percent at any point during the Great Depression.

==> Far from being “rigid downward,” nominal wages fell 20 percent in a single year, according to Vedder and Gallaway.

So all along, my point has merely been to show that the standard explanations for what made the Great Depression so awful are hard to square with the 1920-1921 episode. Even after the utterly anti-Keynesian policies above, the U.S. economy recovered very quickly and ushered in what is known as “The Roaring Twenties.” In contrast, in the 1930s both Hoover and FDR tried fiscal and monetary “stimulus,” and the only excuse Keynesians and monetarists can give is that it was too little too late.

Incidentally, let me point out that even in my book (before Krugman had had a chance to respond to the then-new discussion of 1920-21), I acknowledged that a Keynesian might dispute the interpretation I gave. After walking through how utterly misleading Krugman’s column on “Fifty Herbert Hoovers” was–where he led naive readers to believe Hoover responded to the depression by cutting spending–I wrote in my book:

In fairness, we should concede that there can be no truly controlled experiments in the social sciences. It is theoretically possible that Krugman’s interpretation of history is correct. Presumably he would argue that the 1920-1921 depression was exacerbated (or perhaps even caused) by the enormous cuts in government spending. And he might further argue that Hoover’s profligacy averted unemployment rates of, say, 40 percent in 1931. (The Politically Incorrect Guide to the Great Depression and the New Deal, p. 50)

To be sure, Krugman can always come up with reasons that we can’t draw any lessons from the many historical examples of budget cuts leading to healthy economic recoveries, and why it’s never the fault of stimulus that it always seems to go hand-in-hand with sluggish economies. I mean look, Harding’s name starts with an “H,” while Obama’s starts with an “O.” So why would anybody think his policies and their results have anything to teach us?

I do agree with Krugman on one thing. If more Americans knew more about the history of U.S. business cycles, they might begin to wonder why we never got a Great Depression during any of the previous financial crises, when the dollar was tied to gold and there were no “automatic stabilizers” or other federal regulatory bodies to protect us from the wildcat free market. It’s just another one of those funny coincidences that the worst depression in U.S. history happened to occur right when Presidents Hoover and FDR dramatically expanded the size of the federal government and its ostensible role in fighting depressions.

  • vitalplant09

    Thank you for this post. 1920 was a hard year for everyone.

Profile photo of Robert P. Murphy

Robert P. Murphy is the Senior Economist at the Institute for Energy Research, and a Senior Fellow with the Fraser Institute. He holds a PhD in economics from New York University. Murphy is the author of Choice: Cooperation, Enterprise, and Human Action (Independent Institute, 2015) as well as numerous other books and hundreds of articles.

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