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 “Quantitative 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 stimulus 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 to get off the misery-go-round and embrace the approach which history has shown to work.

Hat Tip: ArthurK at Ace of Spades

Captain Incompetence
Too Cheap To Afford