The Forgotten Depression: A Study in Laissez-faire

LFTThe year is 1921.

America is little more than two years removed from triumph on the Western Front. Warren Gamaliel Harding is its czar. And it is sunk in depression…

U.S. industrial production dropped 31% between 1920 and 1921. Stock prices plunged 46% and corporate profits a ruinous 92%. Official unemployment surged to 12% but may have reached as high as 19%. Storefronts everywhere gaped empty.

It was the grand migraine of the day.

Then suddenly it was over. By 1922 prosperity was finding its legs again.

Welcome, reader, to the Forgotten Depression of 1920-1921…

And forgotten it is, a footnote in the history books. Its sibling, a decade its junior, is the famous one.

But it is entirely possible the Forgotten Depression may have come to be known as the Great Depression, with its decade-long season of economic misery. Yet it didn’t.

Why not?


The doctor let the patient be. In the America of 1921 business looked after itself and buried its own dead. Economy and state were separated by a philosophical wall long since crumbled. And ironing out the business cycle was not the work of government. Despite the Progressive Era’s encroachments and WWI’s assaults laissez-faire had deep roots in American soil. And it had friends in the right places.

If it hadn’t have friends in the right places this downturn might have been the decade-long headache, and the Roaring Twenties and the Jazz Age might be as unknown today as honest government. How America avoided depression in the early ‘20s is a story seldom told.

LFTWhen depression struck in early 1920, President Harding and his henchmen broke every one of today’s commandments. Every one. Did they reach for the checkbook to try and spend the country into recovery? Did they resort to deficit spending? Did they raise taxes on the rich? No, no and no again.

They instead took an ax to the federal budget, nearly severing it in half between 1920 and 1922. They shriveled the national debt by a third. And they slashed taxes A to Z.

If Paul Krugman was around he would have screamed blue murder and set the President down as an enemy of the people. God was kind to the Nobel winner when He chose to inflict him upon the world at a later date. The civil arm of later generations would be much more open to his economic priestcraft.

Every modern economist in good standing knows the government must rush to the scene when disaster strikes. Only direct, massive federal action can revive the failing patient. Spending, deficits, taxes and regulation are the tools in the medical bag.

But Harding followed different lights. He saw through the sham with fierce and knowing eyes. He realized only the old-fashioned medicine of fiscal restraint, balanced budgets and light taxes would lead the nation out of the night.

When’s the last time you heard an American president talk like this?

We will attempt intelligent and courageous deflation, and strike at government borrowing which enlarges the evil, and we will attack high cost of government with every energy and facility which attend Republican capacity. We promise that relief which will attend the halting of waste and extravagance, and the renewal of the practice of public economy, not alone because it will relieve tax burdens but because it will be an example to stimulate thrift and economy in private life.

Let us call to all the people for thrift and economy, for denial and sacrifice if need be, for a nationwide drive against extravagance and luxury, to a recommittal to simplicity of living, to that prudent and normal plan of life which is the health of the republic. There hasn’t been a recovery from the waste and abnormalities of war since the story of mankind was first written, except through work and saving, through industry and denial, while needless spending and heedless extravagance have marked every decay in the history of nations.

Harding prescribed a medicine too stiff for modern America. But it is the right medicine in the proper dose, then and now. Largely because of Harding’s efforts, recovery was already underway by the summer of 1921. Unemployment had peaked at 12%, but was down to 6.7% by the following year. And it was a vanishingly small 2.4% by 1923. And industry was on the jump again.

As one economic historian noted, “The economy rebounded quickly from the 1920–1921 depression and entered a period of quite vigorous growth.”

Again, because of laissez-faire — of letting the market find its own bottom, of letting the laws of supply and demand operate freely, of letting businesses and customers settle on prices. Of leaving the government out of the show. In short, because of liberty, that precious commodity sadly banned from today’s stage. Its absence is what ails us most in this time of economic delirium.

If Harding took the interventionist bait the economy would have been treated to every trick in the bag. Spending, borrowing, welfare, regulation — all of it. And his name may have shined ironically through history as the savior of capitalism a decade before FDR’s. Because that’s how most historians laud Roosevelt and his interventionism, as the savior of capitalism. Someone, somewhere, must be turning in his grave. Perhaps that someone is Harding himself.

FDR’s interventionist policies delivered years of economic depression. Yet he’s the dashboard saint of progressivism and Harding has been read out of history altogether. History is a fickle mistress. But Harding’s inaction was heroic. It was the true savior of capitalism. For a time anyway. After all, the New Deal was just a decade later. Harding’s battle cry, thundering and true, was this: don’t just do something, stand there. It is a battle cry heard no more. It should be resurrected at once.

But it wasn’t just Harding that won the day.

LFTI haven’t even mentioned an even more important figure in the drama: a precocious child actor, seven years old in 1920, called the Federal Reserve.

Its role at the time was simple and it knew it — to provide liquidity to the banking system to prevent another banking crisis. Little more.

This was long before its head was filled with the uplifting, leading-role doctrines of an Alan Greenspan or Ben Bernanke. It had no intention of doing in the business cycle. It didn’t yet realize it could conjure prosperity, genie-like, from the printing press. And QE? What’s that?

So the Fed sat on its haunches when depression struck and the money supply shrank in 1920. In the words of another economic historian, “Despite the severity of the contraction, the Fed did not move to use its powers to turn the money supply around and fight the contraction.”

Instead, and this will send most modern economists to the fainting couch, the Federal Reserve actually increased interest rates during the downturn. No. It’s true…

It raised the discount rate from 4% in 1919 to 7% in 1920, when the depression was showing its fangs. Then it raised rates again to 6% in 1921, when depression was in full throttle. Not until 1922, after the recovery was far along, did it reduce rates to 4% again.

Angels of mercy! Raising interest rates in a depression? Didn’t they know? If only Helicopter Ben was on station to set them straight.

So the budget was cut, the money supply fell and interest rates rose. More favorable ingredients for depression are scarcely imaginable. As the great Jim Grant, who wrote a recent book on the Forgotten Depression of 1920-1921 astutely notes, “By the lights of Keynesian and monetarist doctrine alike, no more primitive or counterproductive policies could be imagined.”

Yet these policies were so destructive the country was out of depression within 18 months. The government stepped out of the way and the economy came up flowers. Impossible by today’s strict standards. Yet true.

Again, laissez-faire.

We can only wonder how the sediment would have settled if the same inaction that followed the depression of 1920-1921 prevailed in 1929. But a decade hence, the interventionist itch proved too strong to resist.

Could the Great Depression have been avoided through determined inaction? Impossible to say for sure, but likely. 1921’s economic numbers were hell-sent. I don’t believe 1929’s were much worse in scale. The country probably would have been up and running in a couple of years had inaction carried the day.

So yes, it’s possible the New Deal, the welfare state, the regulatory state may never have sprouted on these shores. As I said, it’s possible. But equally possible is that they would have hatched down the line out of some national emergency that never occurred in official history. Or out of the natural democratic process. We’ll never know.

But I can’t help but reflect upon a mournful poem — Of all sad words in tongue or pen, the saddest words are these… It might have been.

A free country. It might have been…

The hour grows late and the time-keeper is grabbing the gong.

But before I close I want to bring something to your attention.

The government and the Federal Reserve have botched things beyond repair. But all is not lost. You can take this broken system and work it to your own advantage. In fact, that might be the only way to get on in this topsy-turvy, Alice in Wonderland world of ours.

Thanks for reading.

Brian Maher
Spy Briefing Today

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