The Forgotten Depression
2 March 2015
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4 November 2024
Most people in this country have probably never heard of The Forgotten Depression, the title of a new book by James Grant. Unlike the Great Depression which started in 1929 and lasted until 1941 (in the US), the forgotten depression lasted only eighteen months, from January 1920 until July 1921.
But it was certainly severe. According to Grant, “[t]he nation’s output in 1920-21 suffered a decline of 23.9 per cent in nominal terms, 8.7 per cent in real terms. From cyclical peak to trough, producer prices fell by 40.8 per cent, industrial production by 31.6 per cent, stock prices by 46.6 per cent and corporate profits by 92 per cent.” Not since the early 19th century had prices fallen so far or so fast as in 1920-21.
Why was it over so quickly? Because the successive administrations of Woodrow Wilson and Warren Harding did things that most 21st century economists would regard as disastrous. Confronted with plunging prices, incomes and employment, the government cut spending and balanced the budget. These responses enabled the economy to recover quickly.
They followed the policy that Murray Rothbard urged in his history of America’s Great Depression: “If a government wishes to alleviate, rather than aggravate, a depression, its only valid course is laissez-faire – to leave the economy alone. Only if there is no interference, direct or threatened, with prices, wage rates and business liquidation, will the necessary adjustment proceed with smooth dispatch.”
Prices and wages in the forgotten depression stopped falling when they became low enough to entice consumers into shopping, investors into committing capital and employers into hiring. That is how the price mechanism is supposed to work. To business people who had grown up familiar with the idea of laissez-faire, the government’s approach did not destroy confidence but, on the contrary, actually enhanced it.
President Wilson, a Democrat, was no advocate of laissez-faire. In the summer of 1919 he apparently told friends: “I am perfectly sure that the state has got to control everything that everyone needs and uses.” But in September 1919 Wilson had a serious stroke. From an economic point of view, that turned out to be a stroke of luck! The government that during the First World War had seemed to be everywhere now became inactive. It “did nothing in particular and did it very well.”
Wilson’s successor, Warren Harding, a Republican, was an advocate of laissez-faire. He favoured low taxes and minimal government intervention. By the time he gave his Inaugural Address in March 1921, the depression was nearing its end after fifteen months. To Harding and Andrew Mellon, his Secretary of the Treasury, the situation called for reduced federal spending as well as lower tax rates. In 1922 federal outlays fell to $3.3 billion, compared with $5.1 billion the previous year.
Harding died in August 1923, 27 months after taking office. His successor, Calvin Coolidge, won the 1924 Presidential Election (though not by as large a margin as Harding) and followed the same economic policy.
But the Hoover administration that followed Coolidge early in 1929 took a very different line: It initiated a programme of unprecedented federal activism to head off the threatened economic downturn. After the 1929 Crash, the government’s policy was wage support to “protect the nation’s buying power”. Hoover boasted: “For the first time in the history of great slumps, we have had no substantial reduction in wages.”
In 1921, 92 per cent of reporting firms had reduced wages, but only 7 per cent did so in 1930. By late 1931 real average hourly earnings in manufacturing had increased more than 10 per cent – and manufacturing hours worked had fallen by more than 40 per cent. As a result of this and other misguided policies of Hoover, followed by Franklin D. Roosevelt, the Great Depression was to last a further ten years until 1941.
The evidence from these two serious American Depressions suggests that laissez-faire works, if politicians and people believe in it, while government interference – though undoubtedly well-meant – does not. The moral? Let the market work!
But it was certainly severe. According to Grant, “[t]he nation’s output in 1920-21 suffered a decline of 23.9 per cent in nominal terms, 8.7 per cent in real terms. From cyclical peak to trough, producer prices fell by 40.8 per cent, industrial production by 31.6 per cent, stock prices by 46.6 per cent and corporate profits by 92 per cent.” Not since the early 19th century had prices fallen so far or so fast as in 1920-21.
Why was it over so quickly? Because the successive administrations of Woodrow Wilson and Warren Harding did things that most 21st century economists would regard as disastrous. Confronted with plunging prices, incomes and employment, the government cut spending and balanced the budget. These responses enabled the economy to recover quickly.
They followed the policy that Murray Rothbard urged in his history of America’s Great Depression: “If a government wishes to alleviate, rather than aggravate, a depression, its only valid course is laissez-faire – to leave the economy alone. Only if there is no interference, direct or threatened, with prices, wage rates and business liquidation, will the necessary adjustment proceed with smooth dispatch.”
Prices and wages in the forgotten depression stopped falling when they became low enough to entice consumers into shopping, investors into committing capital and employers into hiring. That is how the price mechanism is supposed to work. To business people who had grown up familiar with the idea of laissez-faire, the government’s approach did not destroy confidence but, on the contrary, actually enhanced it.
President Wilson, a Democrat, was no advocate of laissez-faire. In the summer of 1919 he apparently told friends: “I am perfectly sure that the state has got to control everything that everyone needs and uses.” But in September 1919 Wilson had a serious stroke. From an economic point of view, that turned out to be a stroke of luck! The government that during the First World War had seemed to be everywhere now became inactive. It “did nothing in particular and did it very well.”
Wilson’s successor, Warren Harding, a Republican, was an advocate of laissez-faire. He favoured low taxes and minimal government intervention. By the time he gave his Inaugural Address in March 1921, the depression was nearing its end after fifteen months. To Harding and Andrew Mellon, his Secretary of the Treasury, the situation called for reduced federal spending as well as lower tax rates. In 1922 federal outlays fell to $3.3 billion, compared with $5.1 billion the previous year.
Harding died in August 1923, 27 months after taking office. His successor, Calvin Coolidge, won the 1924 Presidential Election (though not by as large a margin as Harding) and followed the same economic policy.
But the Hoover administration that followed Coolidge early in 1929 took a very different line: It initiated a programme of unprecedented federal activism to head off the threatened economic downturn. After the 1929 Crash, the government’s policy was wage support to “protect the nation’s buying power”. Hoover boasted: “For the first time in the history of great slumps, we have had no substantial reduction in wages.”
In 1921, 92 per cent of reporting firms had reduced wages, but only 7 per cent did so in 1930. By late 1931 real average hourly earnings in manufacturing had increased more than 10 per cent – and manufacturing hours worked had fallen by more than 40 per cent. As a result of this and other misguided policies of Hoover, followed by Franklin D. Roosevelt, the Great Depression was to last a further ten years until 1941.
The evidence from these two serious American Depressions suggests that laissez-faire works, if politicians and people believe in it, while government interference – though undoubtedly well-meant – does not. The moral? Let the market work!
3 thoughts on “The Forgotten Depression”
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Thank you David for adding onto my reading list. What was implied but left unsaid in your post, however, was that the 21st century policy makers are very good at kicking the can further and further in the long grass. But at the onset of the next recession that will inevitably come in a not too distant of a future, the policy makers will no longer have the customary fiscal and monetary stimulus tools available to them. It’s very difficult to stimulate an economy with a starting point of negative interest rates, even though the impact of interest rates on investment is debatable itself as a concept. The longer that market forces are not allowed to act and correct imbalances, the harder the adjustment when the time comes.
Indeed, I think I am correct in saying that the ‘austerity’ budget of 1931 in the UK cut spending and balanced the budget and the UK economy subsequently grew steadily from 1932 onwards for many years (while maintaining approximately balanced budgets).
Yes, HJ, I think you are right about the UK in 1931. Indeed there were similarities between that episode and sterling leaving the Exchange Rate Mechanism in 1992. (The problem wasn’t leaving the ERM on ‘Black Wednesday’ but joining it in the first place.) The reason, though, why I do think the Forgotten Depression of 1920-21 in the US is so noteworthy is the glaring contrast with the Great Depression, which has such a high profile.