The Forgotten Depression: 1921: The Crash That Cured Itself

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Professor Edward W. Politicians also joined the chorus calling for deflation. In his inaugural address in March , President Warren G. Prices must reflect the receding fever of war activities. We must face a condition of grim reality, charge off our losses and start afresh [i. For liquidationists, in contrast, deflation would proceed very rapidly because bankers, investors, entrepreneurs, and consumers expected it to do so.

And they expected it to do so because the intellectual paradigm and the monetary policy regime fostered such expectations. Even though the Fed was up and running, it did not yet see its task as preventing money prices from adjusting to changed conditions of money supply and demand. Contemporary economic observers also did not fret about the modern specter of a runaway deflationary spiral that might result from plunging prices stoking expectations of further declines in prices and inducing consumers and entrepreneurs to delay purchases into the indefinite future.

The reasons they ignored such an eventuality were obvious. First, such an event had never been experienced previously under the gold standard. Second, according to the liquidationist view, credit contraction and deflation was the most expeditious method for realigning money prices and costs, in particular wage rates. It was well understood that capitalists and entrepreneurs did not react to some abstract price level but to actual or expected price margins. Deflation under a freely operating price mechanism did not just lower the height of the price swarm but also deftly reconfigured it so that price margins expanded to the point where entrepreneurial pessimism and malaise gave way to optimism and energetic risk taking.

The liquidationist policy was criticized at the time by a small but notable group of economists, foremost among them Irving Fisher, John Maynard Keynes, and the Swede Gustav Cassel. Cassel denied that gradual deflation was possible and foretold that the Fed would not be able to control the rate of descent of prices or the level to which they would tumble. In any event, as Grant demonstrates, the liquidationists proved to be correct. Both farm prices and wholesale prices plummeted by more than one-third in Unemployment reached Contrary to Cassel and Keynes, deflation did not continue indefinitely or bring about a cessation of all economic activities and business expenditures.

In fact, the U. Paradoxically, in the immediate aftermath of its greatest triumph, the liquidationist position was completely discredited and placed beyond the pale of rational discourse. As Amity Shlaes reminds us, the s did no honor to American public policy. Monetary manipulation, heavy taxation, punitive regulation, public works spending and persistently low interest rates failed to restore the Harding-Coolidge prosperity.

So I turned my attention to the decade that roared. They say that the past is a foreign country. In monetary, banking and regulatory arrangements, the s seem especially alien. Ninety-five years ago, the dollar was defined as a weight of gold and the shareholders of a nationally-chartered bank were responsible for the solvency of the institution in which they owned a fractional interest—which is to say, if the bank failed they got a capital call.

This sword of Damocles was called double liability. People spoke of good times and bad, of boom and bust, but not yet of a macroeconomic whole to be observed, much less to be managed. Wilson and Harding had precious few statistics at their disposal, even if they were inclined to implement the cyclical policies that were yet uninvented. So ill lit was the economic landscape that the Republican Party seemed unaware that a depression was in progress when it convened in June to nominate Warren G. Harding as its presidential candidate. Business activity had peaked five months earlier, in January Maximum joblessness ranged between two million and six million out of a nonfarm labor force of Some today, including the historian Christina Romer, argue that the downturn was little more than a recessionary bump in the road.

Booms not only precede busts, the Austrian school of economics teaches; they also cause them. So it was in The combatants of the Great War had fought on the cuff. They spent more than they raised in taxes, and they borrowed or printed the difference. They abandoned the gold standard almost as soon as the shooting started. The result was an inflation that distorted both prices and judgment. History taught that peace would bring deflation.

When governments stopped printing money for the very purpose of destroying life and property, prices would certainly tumble.


The Forgotten Depression: 1921: The Crash That Cured Itself

They did not tumble. The long-thwarted American consumer celebrated the end of wartime stingency by making the cash registers ring. By the fall of , plants were operating at full tilt, raw materials were unobtainable except at markups to quoted prices and delivery dates were being pushed way out into the future.

Responding to flyaway prices, producers and consumers took actions they would come to regret. Farmers borrowed to purchase marginal acres of cropland, which they planted from fencepost to fencepost. On Nov. Commodity prices started to soften in March, the Japanese silk market being an early deflationary bellwether.

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The price declines were immediate and, in many cases, steep, though they failed to seize the national attention. Certainly, they made no deep impression on the still wet-behind-the-ears Federal Reserve. They were a year early. In a letter to the monetary economist Edwin W. Kemmerer, early in , he predicted exactly how deflationary events would unfold. Prices would be falling and business activity contracting.

One must have a theory of these things to work on, and at least the courage to practice and state it.

Uncommon Knowledge: The Great Depression with Amity Shlaes

He believed that the depression he foresaw was a necessary evil. Wages, like prices, were too high and had to come down. They would fall to sustainable levels sooner or later. If the Federal Reserve could give them a helpful push, so much the better for the timely return to sustainable prosperity. There was no mistaking this American zeitgeist for the Era of Good Feelings.

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In came Prohibition and the unmasking of a swindler named Ponzi. On Sept. By , according to the contemporary reckoning of the English economist T. Still, the successive administrations of Woodrow Wilson and Warren G. Harding hewed to policies of economic nonintervention. With Wilson, it was a case of laissez-faire by accident.

In the war, his administration had rationed, commandeered and regimented without ideological compunction. After the war, it had attacked inflation by the ancient quack remedy of villifying the producers who charged the objectionable prices. Nobody knows what Wilson might have done if he had kept his health.

The stroke he suffered in September incapacitated both him and his administration. Not so the Federal Reserve, which continued to turn the screws. The chairman of the Federal Reserve Board, W. Harding, gave speech after speech proclaiming that better times were at hand. This was not despite falling prices but because of them.

To many people, those particular foundations seemed neither necessary nor stable. Critics included, broadly, the political left; Sen. Robert L. Owen, Democrat of Oklahoma, who had shepherded the Federal Reserve Bill through the upper house of Congress; the economists Irving Fisher, Gustav Cassel and John Maynard Keynes; and the comptroller of the currency, John Skelton Williams, who, as an ex-officio governor of the Federal Reserve, bitterly criticized the high interest rates for which he himself had voted. The scene is an operating room out of the blood-bucket era of orthopedic medicine.

The result, according to new research by the UCLA economist Lee Ohanian, was a rise in real manufacturing wages—and a disastrous drop in manufacturing hours worked. Just how paradoxically enlightened were the supposedly primitive ideas of and did not become evident till after the s had run their course. Downwardly mobile wage rates were one such constructive feature of the forgotten depression. It helps to recall that the gold value of the dollar was fixed. Prices and wages were expected to do the adjusting, if adjustment was called for. As prices were deflating, so should wages fall, reasoned the business and financial community.

Wages would not and should not fall, Samuel Gompers, president of the American Federation of Labor, countered. Working people had not yet regained the purchasing power they had lost in the war. The fact is that wage rates did drop in the early s, though by exactly how much is unknown.

The decline was steep enough to prevent the evisceration of business profits that would otherwise have occurred and that, in the s, did occur, along with its complement, mass unemployment. The restoration of profits at lower levels of prices and wages made a signal contribution to the blooming recovery of the early s.

The depression was 15 months old when Harding moved into the White House. Mellon—banker, industrialist and a director of no fewer than 60 corporations—knew full well how hard were the times. He subsequently described the crisis of as among the most severe in American history.

Now it laid out that much and more in annual debt service. Uncounted millions of unemployed people were pleading for work; tax cuts and spending reductions were the means to providing it: Such was the bedrock of the Harding-Mellon economic plan. Harding prevailed. Inventories and the payroll had both been chopped in half. As duPont had liquidated its inventories, so had its customers and suppliers reduced theirs.

It stood to reason that restocking would prove a potent stimulant—which, indeed, it did. Mellon did not immediately get the tax cut he wanted, but the Federal Reserve, beginning in the spring of , did begin to implement the interest-rate reductions for which he had quietly lobbied.

Coca-Cola, in which punters had earlier speculated as a play on the new Prohibition law, was one such comely bargain.

THE FORGOTTEN DEPRESSION: , the Crash That Cured Itself -

Gillette Safety Razor Co. The springtime thaw in Federal Reserve interest-rate policy was by no means the only, or most important, source of monetary stimulus. Sky-high real American interest rates and rock-bottom American asset values pulled in gold from abroad. President Harding had aimed to restore business confidence. Foreigners expressed their confidence by sending money. Over and done within 18 months, the depression of was the beau ideal of a deflationary slump, I judge. The banking system survived without a single major failure, even if certain eminent New York institutions wobbled and hundreds of country banks closed.

Though painful, the depression was hardly pointless. It rebalanced costs and prices and corrected the investment errors of the inflationary boom.

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Contemporaries mainly withheld their applause. The virtue of downward flexibility in wage rates was less obvious to the many whose wages had declined there was, of course, no federal safety net. Stability became the public-policy watchword of the mid and late s.

The Forgotten Depression: 1921: The Crash That Cured Itself The Forgotten Depression: 1921: The Crash That Cured Itself
The Forgotten Depression: 1921: The Crash That Cured Itself The Forgotten Depression: 1921: The Crash That Cured Itself
The Forgotten Depression: 1921: The Crash That Cured Itself The Forgotten Depression: 1921: The Crash That Cured Itself
The Forgotten Depression: 1921: The Crash That Cured Itself The Forgotten Depression: 1921: The Crash That Cured Itself
The Forgotten Depression: 1921: The Crash That Cured Itself The Forgotten Depression: 1921: The Crash That Cured Itself
The Forgotten Depression: 1921: The Crash That Cured Itself The Forgotten Depression: 1921: The Crash That Cured Itself
The Forgotten Depression: 1921: The Crash That Cured Itself The Forgotten Depression: 1921: The Crash That Cured Itself
The Forgotten Depression: 1921: The Crash That Cured Itself The Forgotten Depression: 1921: The Crash That Cured Itself

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