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A Tale of Three Depressions

It was the best of times, it was the worst of times...

And the Progressives are making the same damn mistake that made them the worst of times.

The "Great Depression" was far from the first depression in the history of the United States. In point of fact, it was not even the first nor the sole depression of the 20th century. The less known one was the depression of 1920, and it was far sharper than the "Great Depression."

The Forgotten Depression of 1920

By Thomas E. Woods Jr. | Mises Daily

It is a cliché that if we do not study the past we are condemned to repeat it. Almost equally certain, however, is that if there are lessons to be learned from an historical episode, the political class will draw all the wrong ones -- and often deliberately so.


The conventional wisdom holds that in the absence of government countercyclical policy, whether fiscal or monetary (or both), we cannot expect economic recovery -- at least, not without an intolerably long delay. Yet the very opposite policies were followed during the depression of 1920-1921, and recovery was in fact not long in coming.

The economic situation in 1920 was grim. By that year unemployment had jumped from 4 percent to nearly 12 percent, and GNP declined 17 percent. No wonder, then, that Secretary of Commerce Herbert Hoover -- falsely characterized as a supporter of laissez-faire economics -- urged President Harding to consider an array of interventions to turn the economy around. Hoover was ignored.

Instead of "fiscal stimulus," Harding cut the government's budget nearly in half between 1920 and 1922. The rest of Harding's approach was equally laissez-faire. Tax rates were slashed for all income groups. The national debt was reduced by one-third.

The Federal Reserve's activity, moreover, was hardly noticeable. As one economic historian puts it, "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."[2] By the late summer of 1921, signs of recovery were already visible. The following year, unemployment was back down to 6.7 percent and it was only 2.4 percent by 1923.

Given that employment is a lagging indicator, that is one damn fast recovery, not to mention a robust one.

So, one might ask, why are we not emulating the practices which produced that roaring recovery?

It is not enough, however, to demonstrate that prosperity happened to follow upon the absence of fiscal or monetary stimulus. We need to understand why this outcome is to be expected -- in other words, why the restoration of prosperity in the absence of the remedies urged upon us in more recent times was not an inconsequential curiosity or the result of mere happenstance.
Indeed. It seems that the corollary of the Progressive call to arms (That didn't work, let's try it again!) is "Who cares if that worked, your theory is hopeless."

First, we need to consider why the market economy is afflicted by the boom-bust cycle in the first place. The British economist Lionel Robbins asked in his 1934 book The Great Depression why there should be a sudden "cluster of error" among entrepreneurs.

Given that the market, via the profit-and-loss system, weeds out the least competent entrepreneurs, why should the relatively more skilled ones that the market has rewarded with profits and control over additional resources suddenly commit grave errors -- and all in the same direction? Could something outside the market economy, rather than anything that inheres in it, account for this phenomenon?

Ludwig von Mises and F.A. Hayek both pointed to artificial credit expansion, normally at the hands of a government-established central bank, as the nonmarket culprit. (Hayek won the Nobel Prize in 1974 for his work on what is known as Austrian business-cycle theory.) When the central bank expands the money supply -- for instance, when it buys government securities -- it creates the money to do so out of thin air.

This money either goes directly to commercial banks or, if the securities were purchased from an investment bank, very quickly makes its way to the commercial banks when the investment banks deposit the Fed's checks. In the same way that the price of any good tends to decline with an increase in supply, the influx of new money leads to lower interest rates, since the banks have experienced an increase in loanable funds.

Ah yes, Fannie and Freddy, which got us into the current mess in the first place. And what have the solons of Washington been doing? Monetizing debt (creating money from thin air) under the rubric of "Quantatative Easing."

Note also that the precipitating factor of the business cycle is not some phenomenon inherent in the free market. It is intervention into the market that brings about the cycle of unsustainable boom and inevitable bust.[10] As business-cycle theorist Roger Garrison succinctly puts it, "Savings gets us genuine growth; credit expansion gets us boom and bust."[11]
Indeed. And the check of this would be the current "recovery" which is the weakest such recovery in our history.

The experience of 1920-1921 reinforces the contention of genuine free-market economists that government intervention is a hindrance to economic recovery. It is not in spite of the absence of fiscal and monetary stimulus that the economy recovered from the 1920-1921 depression. It is because those things were avoided that recovery came. The next time we are solemnly warned to recall the lessons of history lest our economy deteriorate still further, we ought to refer to this episode -- and observe how hastily our interrogators try to change the subject.
It seems likely to me that the stimulous programs undertaken to date have not improved the situation, and that we are on the verge of a second dip to our "Great Recession" which will make it our third Depression (since the turn of the 20th Century and second "Great Depression") if we continue as we have begun. Time of get off the misery-go-round and embrace the approach which history has shown to work.

Hat Tip: ArthurK at Ace of Spades


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Comments (23)

Thanks for putting this up.... (Below threshold)

Thanks for putting this up. I try to comment when it's appropriate about the 1920-21 recession and the lessons which should have been - but because of the Progressive and neo-Keynesian obstacles - have not been learned and certainly not applied. We are in the deadly embrace of - as Mike Shedlock puts it - the Keynesian Klowns. Remember the most important price in any economy is the price of money, i.e. the interest rate, since it determines the nature of investment decision making. Is a mandated interest rate of .25% a true market rate? Bubble making here we come!

First the Fed in 1920-21 did NOT have any macroeconomic mandate such as it does now. It's one and only responsibility was to prevent financial panics by providing emergency liquidity to the banking system. Thus, it was not empowered to interfere in the macroeconomy. Or, should I say, assist in bubble blowing. Although not mentioned here, the interest rate was RAISED, thus forcing the liquidation of unproductive assets, clearing the deck for productive investment and growth.

Second, the 1920-21 recession was a credit recession, which is what we are suffering now. The macroeconomy had been distorted in 1914-18 by the U.S. industrial and agricultural response to WWI. As a consequence the economy needed to liquidate the now malinvestment which had aimed to supply the demand of a war economy. Enter higher prices for money and lower government expenditures.

I don't want to get too deep into Austrian economics, but we now have a distorted U.S. - and world economy - built to service demand built on debt. We now find that the subprime trigger has started the collapse of the whole house of cards. The debt levels in most of the developing world are not just unsustainable, but probably unpayable.

The policy prescription to get us out of the low employment, falling demand, and rampant malinvestment is to let prices find their free market equilibrium. Unfortunately, there will be unavoidable short term pain and suffering and no politician - that I can see - is willing to tell the truth about this. But unless the trash is taken out to let real capital flow to productive investments, we will have decades of stagnation (at best) in the future that will look much like what we see now.

We're assuming they don't w... (Below threshold)
Don L :

We're assuming they don't want such to happen. I don't.

"A Tale of Three Depression... (Below threshold)

"A Tale of Three Depressions"

I think Barry can even do better then that.

Hmm. Interesting. ... (Below threshold)
James H:

Hmm. Interesting.

Of course, at least two thi... (Below threshold)

Of course, at least two things are worth noting:

1. A major cause, perhaps the major cause, of the 1920 depression was the end of World War 1. This had the simultaneous effect of reducing production, and creating hundreds of thousands of unemployed ex-soldiers back to America.

So there were less things being made, and more people looking for jobs making them. And this problem faded as more people found work.

2. Hoover tried all the things which seemed to get us out of the 1920 depression first. He cut reparation payments of war loans, he refused to increase the budget with direct aid to farmers and the poor, and he cut taxes on the wealthy.

None of it worked, and things continued to get worse. Hoover then tried some actual projects and such to benefit the economy, but it was too late. Then FDR was put in, and astronomically increased governemnt spending in support of the lower and middle class, while creating infrastructure and increasing production. And, as I've posted here numerous times ad nauseam, the overwhelming majority opinion of unbiased economists and economic historians is that FDR's policies DID work, and DID get us out of the Great Depression rather than prolong it.

If any here can be swayed by it, that's the historical situation. I expect some points to surface in response that I've dealt with in the past, but no problem; I'll deal with them again.

Jim x,Read the who... (Below threshold)
Rodney Graves Author Profile Page:

Jim x,

Read the whole article.

I further note (with amusement) your failure to acknowledge Smoot-Hawley Tariff (P.L. 71-361).

There's stuff going on toda... (Below threshold)

There's stuff going on today that prior recoveries never had to deal with, and which should scare the crap out of everybody. Among other things: the progressive weakening of the dollar, the increasing cost of energy, and the uncertainty caused by the bizarre Obamacare scam. Not to mention the deficit. It's worse than you think:

Lawrence B. Lindsey: The Deficit Is Worse Than We Think [converted URL to link, RGG]

OK, sure Rodney. Feel free ... (Below threshold)

OK, sure Rodney. Feel free to note that too. : )

If you can quote how the article deals specifically with the points I raised, I'll be happy to read it. But as quoted in this article, it comes off as slanted to the point of unfactual.

Jim x,If you have ... (Below threshold)
Rodney Graves Author Profile Page:

Jim x,

If you have no interest in reading the full article, why are you opining on it?

Rodney,I'm opining... (Below threshold)


I'm opining on *your* article. You are making statements based on it, and it is those statements and the general notion of "The 1920 Depression proves the Progressives are all wrong!" that I'm disagreeing with.

If you know that the article disproves my points, then please show me how and where.

Jim x claims:<blockqu... (Below threshold)
Rodney Graves Author Profile Page:

Jim x claims:

'm opining on *your* article.

When the last quoted portion of the relevant article states:

The experience of 1920-1921 reinforces the contention of genuine free-market economists that government intervention is a hindrance to economic recovery. It is not in spite of the absence of fiscal and monetary stimulus that the economy recovered from the 1920-1921 depression. It is because those things were avoided that recovery came.
With Barry its 'Back in the... (Below threshold)

With Barry its 'Back in the 20s tonight!'

Not to worry, Barry wants a... (Below threshold)

Not to worry, Barry wants a depression of his very own.

Gotta make the history books for something other than being the first Affirmative Action President.

Rodney Graves apparently cl... (Below threshold)

Rodney Graves apparently claims somehow that, because an article he wrote heavily quotes from another article, and because the last quote from that article is also something he agrees with, somehow that makes me wrong.

How's that work again?

Jim Beach seems to thing th... (Below threshold)
Rodney Graves Author Profile Page:

Jim Beach seems to thing that argument by assertion, where the other side has presented sources, carries some kind of weight.

How does that work again?

Jim x wrote, "Hoover tried ... (Below threshold)

Jim x wrote, "Hoover tried all the things which seemed to get us out of the 1920 depression first. He cut reparation payments of war loans, he refused to increase the budget with direct aid to farmers and the poor, and he cut taxes on the wealthy."

Jim, you need a refresher course on Herbert Hoover and the Great Depression: http://wizbangblog.com/content/2009/03/12/herbert-hoover-revisited-1.php.

Immediately after the October 1929 crash, Hoover met personally with union bosses and with the heads of the telephone, steel, automotive, and construction industries, and encouraged these businesses to continue expansion programs and promise not to cut wages, and to shorten work weeks rather than lay off workers. He also approved hundreds of millions of Federal dollars for state-sponsored infrastructure projects, Federal farm subsidies, and subsidies for heavily unionized industries. In addition, the Federal Reserve pumped $300 million in cash into the nation's biggest lending banks and encouraged them to expand credit.

But in order to keep foreign competition from damaging the artificially high prices (and wages) that resulted from government subsidies, Hoover was forced to sign the Smoot-Hawley tariff bill. He was also forced to drastically raise income taxes in 1932 in order to pay for the billions of dollars in government subsidies that his administration had paid out.

The only two major Federal policy changes enacted by FDR that differed from the policies already in place via the Hoover Administration were 1) the payment of obligation-free cash benefits directly to individuals, and 2) the direct take-over of banks (albeit temporarily) by the Federal government. All the rest of FDR's "miracle" New Deal programs were just extensions of programs that had been tried -- and in hindsight had failed -- at the hands of the Hoover administration.

Rodney Graves thinks that a... (Below threshold)

Rodney Graves thinks that argument by assertion is fine when he does it, and fine when an article he cites does it - however when Jim X disagrees with him, says why, and offers to back it up, Rodney asserts that Jim should just read the entire original article.

Rodney is quite within his rights to think this constitutes a refutation, and Jim is quite within his rights to point out that is ludicrous.

However, any time Rodney wishes to stop evading and get back to the topic at hand, Rodney is free to actually provide quotes which refute Jim's statements.

Let's see what happens.

Michael,Excellent ... (Below threshold)
Rodney Graves Author Profile Page:


Excellent points, and I would have linked to your article had I remembered it.

Jim Beach,

My points all logically flowed from the source I cited and quoted at length. Your counter "arguments" were un-supported assertion.

1. A major cause, perhaps the major cause, of the 1920 depression was the end of World War 1. This had the simultaneous effect of reducing production, and creating hundreds of thousands of unemployed ex-soldiers back to America.


2. Hoover tried all the things which seemed to get us out of the 1920 depression first. He cut reparation payments of war loans, he refused to increase the budget with direct aid to farmers and the poor, and he cut taxes on the wealthy.

Nary a source in sight.

Michael was kind enough to treat your arguments by assertion with a linked refutation, while your first "point" was indeed addressed at some length in the article you still refuse to read.

Your not really here for a debate, are you?

Michael, you could use a re... (Below threshold)

Michael, you could use a refresher course on what actually happened historically according to nonpartisan experts, and not merely right-wing spin.

First, I'll note that not one thing you said contradicts my quoted statement.

Second, since Hoover and others state that he called in these business leaders and had the conversations you describe, let's say that's so.

Here's what Hoover also did:

- rejected direct federal relief payments to individual

- resisted creating a budget deficit to fund welfare programs

- resisted creating government projects to put people to work until the last moment, after everything else failed - in 1932. Which was, as I previously stated, too late. And also too little. Which is why he lost the Presidency.

To suggest that the "only two major Federal policy changes enacted by FDR" were paying obligation-free benefits and the direct take-over of banks, is faulty. To be polite. Here's a short list of other HUGE policy changes enacted by FDR:

- abandoned the gold standard

- created the Home Owners Loan Corporation, to refinance foreclosed homes

- pushed and signed the Glass-Steagal act - which kept us from a huge triple-crash of investment banking, loan banking and mortgage banking until 2008. It was repealed in 1998.

- Social Security

- created the Civilian Conservation Corp, specifically to employ young man

- created the Tennesee Valley Authority, specifically to bring electricity to blighted rural areas

...and that's the short list.

So, once again, please study up on what actually happened, and not just what makes you ideologically comfortable.

My points all logi... (Below threshold)
My points all logically flowed from the source I cited and quoted at length. Your counter "arguments" were un-supported assertion.

Well, except that they're actually accepted mainstream historical fact. Be that as it may, you then asked me to read the full article. My response was, what part of the full article refuted or disproved these "unsupported assertions"?

You produced nothing. So, they stand until you actually produce something that refutes them.

But if you want to me my sources? Sure, no problem. Here you go.

Re: unemployment as a major cause in the 1920-1921 depression:


...Adjusting from war time to peace time was an enormous shock for the U.S. economy. Factories focused on war time production had to shut down or retool their production....One of the biggest adjustments was the re-entry of soldiers into the civilian labor force. ...The impact on the labor market was most striking in 1920, when the civilian labor force increased by 1.6 million people, or 4.1%, in a single year (though smaller than Post-World War II demobilization in 1946 and 1947, it is otherwise the largest documented one-year labor force increase).

And re: Hoover and his response to the Great Depression:


Hoover's stance on the economy was based largely on voluntarism....Hoover feared that too much intervention or coercion by the government would destroy individuality and self-reliance, which he considered to be important American values.

...Which, I think we can both agree, is not a typical liberal stance. Which is why it always makes me laugh to here Hoover referred to as some sort of progressive. To continue:

Hoover rejected direct federal relief payments to individuals, as he believed that a dole would be addictive, and reduce the incentive to work. He was also a firm believer in balanced budgets, and was unwilling to run a budget deficit to fund welfare programs.

[in 1932] Hoover and the Congress approved the Federal Home Loan Bank Act...The plan seemed to work, as foreclosures dropped, but it was seen as too little, too late.

Prior to the start of the Great Depression, Hoover's first Treasury Secretary, Andrew Mellon, proposed and saw enacted, numerous tax cuts, which cut the top income tax rate from 73% to 24%

...which also is worth noting, since the Great Depression that followed is basically proof that tax cuts aren't some sort of panacea...

The final attempt of the Hoover Administration to rescue the economy occurred in 1932 with the passage of the Emergency Relief and Construction Act...The RFC had minimal impact at the time, but was adopted by President Franklin D. Roosevelt and greatly expanded as part of his New Deal.
Above I referred to the Gla... (Below threshold)

Above I referred to the Glass-Steagal Act being repealed in 1998 - actually, it was in 1999.

Also it's worth noting that Bill Clinton signed the piece of crap. This repeal which helped created the conditions that led to the collapse of 2008 was truly a bipartisan screwup.

while your first "... (Below threshold)
while your first "point" was indeed addressed at some length in the article you still refuse to read.

Then please, by all means, show the part of the article that *refutes* it. The only bit you've quoted so far does not specifically reference the points I've made.

The current situation is mu... (Below threshold)

The current situation is much different. We face an economy with 70 pct of economic activity based on consumer spending, increasing debt and spending across various sectors (not just government), four decades of trade deficits, a government deficit driven primarily by tax cuts and war costs, and in general absurd levels of spending (e.g., a country with less than 5 pct of the world's population but consumes up to 25 pct of world oil production). Meanwhile, as the government kept deregulating from '81 onwards, corporations continued outsourcing and later profiting heavily from financial speculation.

Thus, it is expected that the three sectors (households, businesses, and government) are now starting to blame each other even though all three profited from each other and borrowed and spent heavily. And since it is very likely that none of them will want to cut down on spending and borrowing, then there will be no recovery for the U.S.






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