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Don’t Just Do Something, Sit There!

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Have you heard of the depression of 1920-21?

Unless you’re a pretty hard-core economics geek, you probably haven’t.

The most striking aspect of this depression was its duration. It lasted just 18 months. And how did the US get itself out of this sharp economic downturn?

By essentially doing nothing.

A collapse in GDP and production led to a sharp spike in unemployment to double-digit numbers. Modern policymakers would immediately launch economic stimulus. Consider the 2008 crash. On top of government programs such as the $700 billion TARP and $800 billion in fiscal stimulus, the Federal Reserve pumped $4 trillion in new money into the system. For 165 out of 180 months, the Fed pushed interest rates down or held them at rock-bottom levels.

The result? A tepid recovery at best with 2 million fewer “breadwinner” jobs than during the 1990s. Oh. And a whole slew of bubbles waiting to pop.

Lew Rockwell compares this to the how things played out in 1920.

By the time the federal government even began considering intervention, the crisis had ended. What Commerce Secretary Herbert Hoover deferentially called ‘The President’s Conference on Unemployment,’ an idea he himself had cooked up to smooth out the business cycle, convened during what turned out to be the second month of the recovery, according to the National Bureau of Economic Research (NBER). Indeed, according to the NBER, which announces the beginnings and ends of recessions, the depression began in January 1920 and ended in July 1921.”

In fact, monetary policy during this period was actually contractionary. Allan Meltzer wrote in  A History of the Federal Reserve that “principal monetary aggregates fell throughout the recession.” He calculates a decline in M1 by 10.9% from March 1920 to January 1922, and in the monetary base by 6.4% from October 1920 to January 1922. “Quarterly average growth of the base,” he continues, “did not become positive until second quarter 1922, nine months after the NBER trough.”

Rockwell outlines some of the other policies in place during the 1920-1921 depression he gleaned from Jim Grant’s new book The Forgotten Depression — 1921: The Crash That Cured Itself.

The Fed raised its discount rate from 4% in 1919 to 7% in 1920 and 6% in 1921. By 1922, after the recovery was long since underway, it was reduced to 4% once again. Meanwhile, government spending also fell dramatically; as the economy emerged from the 1920–21 downturn, the budget was in the process of being reduced from $6.3 billion in 1920 to $3.2 billion in 1922. So the budget was being cut and the money supply was falling. ‘By the lights of Keynesian and monetarist doctrine alike,’ writes Grant, ‘no more primitive or counterproductive policies could be imagined.’ In addition, price deflation was more severe during 1920–21 than during any point in the Great Depression; from mid-1920 to mid-1921, the Consumer Price Index fell by 15.8%. We can only imagine the panic and the cries for intervention were we to observe such price movements today.”

This is all the exact opposite of what the central planners say must happen during a downturn. In fact, the government and central bankers got their acts together and did all the right things during the 1930s. And perpetuated a decade of depression.

So perhaps we don’t need all of the intervention, stimulus, financial mechanizations, and tinkering with interest rates that the central planners claim we have to have to keep the economy afloat. Maybe markets really can correct themselves. I like the way Rockwell put it.

The example of 1920–21 was largely overlooked, except in specialized treatments of American economic history, for many decades. The cynic may be forgiven for suspecting that its incompatibility with today’s conventional wisdom, which urges demand management by experts and an ever-expanding mandate for the Fed, might have had something to do with that. Whatever the reason, it’s back now, as a rebuke to the planners with their equations and the cronies with their bailouts.”

 

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