1920: The Great Depression That Wasn't

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The Panic of 1920 started out as a contender for the greatest depression of all time, with a drop in prices and production during its first twelve months that dwarfed those of any other economic crash, and she piled on an unemployment rate that skyrocketed from invisible to 12% in a flash. Ignoring calls to do something, anything, to "help", Washington, DC simply allowed the economy to adjust wherever it chose to go. In tandem, Federal Reserve officials looked upon the rapid deflation in prices not with horror but with a declaration of its necessity. Yet, despite the lack of government intervention and monetary "pump-priming", the economy corrected itself within two years. As a modern day American, I can hardly imagine.

Prior to the denouement, the Fed money spigot had been on full blast for seven years; an index of wholesale prices had surged from a base of 100 in 1913 to 226 in early 1920. One economist from the time noted a concurrent "outbreak of speculation in business and stock market circles that for recklessness has had few parallels".

The storm broke in May of 1920 and arrived as these things usually do - almost everyone at the opera was caught napping when the lights suddenly came on. Bank failures, which numbered 63 in 1919, spiked to 506 by 1921. By June of the latter year, the money supply had dropped 9%, GNP 17%, and the index of wholesale prices collapsed from 247 in May of 1920 to 141 by July of 1921. To this day, the index has yet to show a more precipitous drop in such a short time.

Across America, the suffering began.

The prevailing opinion on the proper response was summed up in Warren G. Harding's speech as he accepted the 1920 Republican presidential nomination. He pledged an "intelligent and courageous deflation, and (to) strike at the government borrowing which enlarges the evil". He was a man of his word. Between 1920 and 1922, the federal budget fell by almost one half, tax receipts by 38%, and outstanding debt by 5%. Meanwhile, Federal Reserve officials made no attempt to maintain prices at any level.

With prices allowed to adjust, the recovery was already underway by August of 1921. Between then and 1923 manufacturing production in the US rose 48% while unemployment declined to 2.4%. The depression of 1920 was notable not only for its quick turnaround but also for its absence of political and monetary intervention. In many ways it was to be the curtain call for American laissez faire; to read of 1920 today sounds not only of another time but of another country altogether.

Today there are more fish swimming the Sahara Desert than people in DC who would dare utter such things as Warren G. Harding once spoke. If President Obama called for "intelligent and courageous deflation" he'd be tossed into the Time Out Corner with Ron Paul and derided as a lunatic. Yet, the short-lived Panic of 1920 suggests that there may be other options available than just more inflation and debt - that we can seek economic recovery by doing absolutely nothing, by allowing our much ballyhooed free market for once to be just that - free.

Harding's depression, one of far greater initial ferocity than 1929, lasted barely two years. In contrast a meddling Herbert Hoover passed a fat and healthy depression to FDR, who nurtured, loved, and stuffed it to bursting with the New Deal. Why don't we try Harding's response? He has the far better track record.

Instead, today our Fed officials artificially set their fund rate at zero - during a time of extreme economic distress - then wonder why nobody is willing to lend, all in a misguided effort to ward off falling prices for all, bankruptcy for the insolvent, and to keep money "cheap". I believe that it is not money that lubricates an economy, but prices. Prices are the clearing mechanism that moves goods and services efficiently. Break down the price mechanism - and constant political and monetary interventions are an excellent way to do so - and you can have all the money supply that trees can provide and it will do nothing of any benefit.

While we may look upon Fed officials from 1920 as ignorant oafs who did not understand monetary policy (and so failed to "re-inflate" prices), we fail to consider that in our response we might have it wrong. This is not a knock on the modern day American economist; forgetting to remember something important is nothing new. A group of economists remarked in 1937 on "the melancholy fact that each generation must relearn the fundamental principles of money in the bitter school of experience". Yet, while our faulty memory is tragic, to me a far greater defect within us has been revealed by the current economic trauma.

Once upon a time, our forefathers stormed ashore at Normandy into the teeth of German machinegun fire with nothing between them and Heaven but a khaki shirt; while today far too many of us tremble at the mere thought of our largest banks and other institutions collapsing into their well-deserved bankruptcy. To me, this fear of taking our medicine is the saddest spectacle of all. While that Greatest Generation fought Hitler's Wehrmacht so that we, their descendants, would never have to, today we are sticking our descendents with trillion dollar bailout bills for fear of our well-earned comeuppance.

What will future generations say of us?

CJ Maloney lives and works in New York City. All opinions expressed are his alone. He blogs for Liberty & Power on the History News Network website and the DailyKos. His first book Back to the Land (Arthurdale, FDR’s New Deal, and the Costs of Economic Planning) is to be released by John Wiley and Sons in March 2011. He may be reached at peloponny1@aol.com

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