The Forgotten Depression

May 26, 2015

When the next big economic disaster hits, Washington will almost certainly choose to do something: cut taxes, increase spending, lower interest rates. There is another option, of course: do nothing. No fiscal or monetary stimulus. Let the fire burn the rot of excess from the system. From the ashes, goes this theory, a healthier, more balanced economy will emerge.

So opponents of government action — Tea Party Republicans, libertarians, devotees of Austrian economics — do have a plan of sorts. What they don’t have is a compelling story to persuade policy makers or the public. The high school history book lesson of the Great Depression — government inaction in the face of economic upheaval courts collapse — dominates. Much like the Tin Woodman in that Depression-era classic movie, “The Wizard of Oz,” austerians and liquidationists require a testimonial. And it is the need for a success story that drives “The Forgotten Depression,” by the financial journalist James Grant, the founder of Grant’s Interest Rate Observer. Subtitled “1921: The Crash That Cured Itself,” the book tells the tale of the other great slump of the early 20th century.

Pre-World War II economic data can be dodgy, but by the measures Grant prefers, the 1920-21 downturn saw output fall by nearly 10 percent, stock prices cut almost in half and unemployment surge to about a fifth of the labor force. The contraction’s severity can be seen in words as well as numbers. Grant points out the “bitterly sardonic” lyrics of the 1921 hit “Ain’t We Got Fun,” a song often associated with Roaring Twenties ebullience but one that he says was inspired by the decade’s depressionary start: “In the winter, in the summer / Don’t we have fun? / Times are bum and getting bummer / Still we have fun.”

But music failed to soften hearts in Washington. Instead of splurging on shovel-ready jobs to stimulate growth, the budget was balanced. And rather than cut interest rates to boost borrowing, the new Federal Reserve tightened the money supply. As Grant writes: “The successive administrations of Woodrow Wilson and Warren G. Harding met the downturn by seeming to ignore it — or by implementing policies that an average 21st-century economist would judge disastrous. . . . Yet by late 1921, a powerful, job-filled recovery was underway. This is the story of America’s last governmentally unmedicated depression.”

For Grant’s flavor of austere, micro-government conservatism to expand its appeal, this is a story that must be told. The Great Depression narrative not only informs modern policy responses during crises, it’s also the ur-justification for big government. But the present Not-So-Great Recovery — despite an $800 billion fiscal stimulus and inventive Fed monetary policy — has perhaps cracked open the window for a different story, one of “instructive inaction.” And if the better way to deal with a downturn is for government to do nothing, then maybe government should do a whole lot less in other areas of life as well. Grant’s forgotten depression is considered a natural economic experiment in economic freedom by those who think the American project went horribly off track with Franklin Roosevelt’s election in 1932.

Yet whatever the broader merits of Grant’s minimalist philosophy, the supposed hands-off approach to the 1920-21 depression provides a poor argument for it. Grant’s laissez-faire depression was actually an economic episode in which government — via its new central bank — played an active and critical role throughout. Grant himself concedes that “easier money” helped account “for the power of the 1922 rebound.” A better natural experiment for Grant’s depression-fighting formula is what’s happening in the eurozone right now. With a jobless rate over 11 percent, a combination of fiscal austerity and tight money is on the verge of sending the region into its third recession since 2007. But who knows, maybe it will generate a catchy tune or two.

Grant’s book is a lively exercise in economic nostalgia, a game effort to build a bridge to the pre-New Deal era when the tax burden was tiny, the dollar defined by gold and government let business do as it would. But as an economic guide for 21st-century policy makers in a crisis, the forgotten depression is best forgotten.


Courtesy of Sunday Book Review

Spanish Conquistadores invaded the Inca Empire in 1528 to steal their silver and gold.