Why You Should Remember the Forgotten Depression of 1920

One of the ways to begin a New Year is to examine reflectively the days gone by. This article was originally published in the Fall 2009 issue of the Intercollegiate Review.

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.

Far from viewing the past as a potential source of wisdom and insight, political regimes have a habit of employing history as an ideological weapon, to be distorted and manipulated in the service of present-day ambitions. That’s what Winston Churchill meant when he described the history of the Soviet Union as “unpredictable.”

For this reason, we should not be surprised that our political leaders have made such transparently ideological use of the past in the wake of the financial crisis that hit the United States in late 2007. According to the endlessly repeated conventional wisdom, the Great Depression of the 1930s was the result of capitalism run riot, and only the wise interventions of progressive politicians restored prosperity.

Many of those who concede that the New Deal programs alone did not succeed in lifting the country out of depression nevertheless go on to suggest that the massive government spending during World War II is what did it. (Even some nominal free marketeers make the latter claim, which hands the entire theoretical argument to supporters of fiscal stimulus.)

The connection between this version of history and the events of today is obvious enough: once again, it is claimed, wildcat capitalism has created a terrific mess, and once again, only a combination of fiscal and monetary stimulus can save us.

In order to make sure that this version of events sticks, little, if any, public mention is ever made of the depression of 1920–1921. And no wonder—that historical experience deflates the ambitions of those who promise us political solutions to the real imbalances at the heart of economic busts.

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 laissezfaire. 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.” By the late summer of 1921, signs of recovery were already visible. The following year, unemployment was back down to 6.7 percent and was only 2.4 percent by 1923.

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Photo courtesy of Faylyne, 2013.