Horwitz on the 1920-1921 Depression
I’ve actually been working this week–my psyche has yet to adjust to the discomfort–and somehow this post by Steve Horwitz slipped through the cracks. For non-Austrian readers, some quick context:
(1) Many, perhaps most, economists today would say something like, “We know that the Fed made a terrible mistake in the early 1930s, by standing back and letting the money supply fall by 1/3 as panicked depositors withdrew their money from the banking system. The huge deflationary force added insult to injury after the stock market had already crashed, and is why the Great Depression was so awful. Had not Bernanke flooded the system with new money last fall, unemployment would be much higher today than it is.”
(2) In response, many Austrian economists who consider themselves followers of Murray Rothbard say, “That’s nuts. Printing up green pieces of paper doesn’t make us richer. The economy needed to undergo serious rearrangement of resources after the popping of the artificial bubble in 1929. The reason unemployment went so high in the 1930s wasn’t because of the Fed’s unwillingness to print up dollar bills. As proof, look at the depression of 1920-1921, when there was a more severe collapse in the monetary base and price deflation was even more severe.” (I discuss this in great length in my book, but if you are a cheapskate Tom Woods has a good article on it. UPDATE: Tom says this article is a better one to learn about the 1920-1921 experience.)
(3) Steve Horwitz and some other Austrians–typically those who consider themselves followers of Hayek and Kirzner, more than of Rothbard, though the classification is not perfect–disagree. They agree that the Fed screws up things when it prints new money and fuels an artificial boom, but they think the Fed is just committing the opposite mistake if it sits back and does nothing, when the public’s demand to hold money increases during a financial panic. Thus, Horwitz and some other big guns in the Austrian camp agree with Milton Friedman that the Fed’s timidity in the early 1930s contributed to the severity of the Great Depression, and they agree that Bernanke was correct to increase the monetary base last year (though of course they need not, and don’t in practice, agree with how Bernanke chose to get new reserves into the system, namely through bailouts of insolvent financial institutions).
OK now that you’ve got the context, check out Horwitz’s post. He takes the 1920-1921 trump card head-on and argues that it would have been even less painful if the Fed had done what he recommends. In other words, the 1930s was the worst ever, because you had Hoover’s New Deal-lite combined with dumb deflationary Fed policy. The 1920-1921 depression was better than that, but it was still really bad, because you had Harding’s laissez-faire policies combined with dumb deflationary Fed policy.
If I had to give a reaction on the spot, I’d say that I disagree with Horwitz. In particular, I think part of why there was a depression in 1920-1921 was that the huge WW1 bubble was popped, since the Fed had become alarmed by the 20% price inflation. So if that’s right, I don’t see how you could have had the corrective readjustment of resources, without most of the pain that they did in fact experience. Ditto for the fiscal policies: I think there had to be a period of “idle resources” as the US economy reconfigured itself from the arsenal of democracy back into the engine of consumerism.
It’s true, I think if Ron Paul had been elected president and did everything Joe Salerno advised, that there would have been a very severe recession but it would have bottomed out within, say, 6 months. So it does surprise me that the 1920-1921 depression lasted longer than that. Thus, Horwitz could be right.
Last point: Let’s not forget that we’re talking about 1920 here. It’s not as if laid off munitions workers could hop on Monster.com, sublet their apartment on Craig’s List, and then rent a one-way U-Haul to where the new jobs were. I really have no idea how long a massive “free market recession” should have lasted back then, or how high unemployment “should” have been.
