03 Dec 2014

The Rhetorical Significance of the 1920-1921 Depression

Krugman, Shameless Self-Promotion, Tom Woods 36 Comments

My favorite NY Times economist is none too happy that Jim Grant wrote a book on the topic. I’ll let others (like Tom Woods) speak for themselves, but as for me, I am completely unapologetic about what I’ve written. I explain the situation at Mises CA. An excerpt:

What happened in my case is that (in the winter of 2008/09) I was doing research for my book The Politically Incorrect Guide to the Great Depression and the New DealI was going through the common arguments for why the 1930s depression was so awful, and I eventually realized that all of the main reasons you typically hear–often from both Keynesians and Chicago School monetarists–made no sense, because things were much much worse in each of these dimensions in 1920-1921.

Specifically, the Keynesians will say that Herbert Hoover didn’t increase federal spending enough. Monetarists will say that the Fed didn’t ease sufficiently. And both camps will say that the crushing deflation, in combination with sticky wages, led to a downward spiral in spending that caused unemployment to reach record highs.

So in reaction to those types of claims–which remember, are supposed to show us why the 1930s mushroomed into the Great Depression, yielding a decade of despair–I pointed out that in the previous depression of 1920-21:

==> Far from boosting spending, the federal government (under Wilson/Harding) slashed spending 82 percent over three years (that’s not a typo), going from $18.5 billion in Fiscal Year 1919 to $3.3 billion in FY 1922.

==> Far from easing, the Fed engaged in literally unprecedented tightening, with discount rates rising to all-time highs (since the founding of the Fed) and with the monetary basecollapsing some 15 percent year/year (though that’s using the seasonally adjusted data, so some may quibble with the figure).

==> Prices fell more rapidly in one year than at any 12-month span during the Great Depression. From its peak in June 1920 the Consumer Price Index fell 15.8 percent over the next 12 months. In contrast, year-over-year price deflation never even reached 11 percent at any point during the Great Depression.

==> Far from being “rigid downward,” nominal wages fell 20 percent in a single year, according to Vedder and Gallaway.

One last thing: Krugman made his post all about Harding, so that’s why I featured Harding’s picture on my post. But the vast bulk of the spending cuts occurred under Wilson, as World War I ended.

36 Responses to “The Rhetorical Significance of the 1920-1921 Depression”

  1. TravisV says:

    Scott Sumner provided a comprehensive explanation for 1920-21 a long time ago:




    • Major.Freedom says:

      Please explain how an explanation that lacks considerations of economic calculation as well as degrees of intervention versus non-intervention and the effects on price coordination, but includes incorrect descriptions of theory (e.g. “Policymakers allowed the purchasing power of gold to rise gradually during the 1920s, through a policy of mild deflation. (The Austrian solution)” is not an Austrian solution), can constitute a “comprehensive” explanation.

      In this post:


      Sumner does not answer the question he set out to answer. He also couldn’t refute “saifedean” in the comments.

  2. LK says:

    (1) “So all along, my point has merely been to show that the standard explanations for what made the Great Depression so awful are hard to square with the 1920-1921 episode. Even after the utterly anti-Keynesian policies above, the U.S. economy recovered very quickly and ushered in what is known as “The Roaring Twenties.””

    What happened to the Fed funds rates cuts in 1921 and 1922 in your analysis? And the proto-form of quantitative easing by the Fed in which there were open market operations in late 1921–1922 to aid recovery, and in which the Federal Reserve bought government bonds from November 1921 to June 1922 and tripled its holdings from $193 million in October 1921 to $603 million by May 1922 (a fact even noted by Rothbard 2000: 133)??

    Didn’t this — from your Austrian perspective — just induce an Austrian business cycle from 1921 and unsustainable lengthening of the capital structure? So how can you even speak of a proper “recovery”??

    (2) “Far from being “rigid downward,” nominal wages fell 20 percent in a single year, according to Vedder and Gallaway.”

    Yes, but the trouble is that the 1916-1923 period stands out as being highly anomalous in American history for wage movements, given the pressures of the war, the restriction of immigration and then the post-war deflation and resumption of immigration. It is absurd to think that wages today could exhibit that degree of flexibility.


    • guest says:

      “Didn’t this — from your Austrian perspective — just induce an Austrian business cycle from 1921 and unsustainable lengthening of the capital structure?”

      Tom Woods vs. the Fed

      “Second, that prosperity, which included genuine increases in production in the private sector, was also fueled by the Fed increasing the money supply by 55% … With drastically increased production, consumer prices should have been falling; the fact that they were constant throughout the decade was evidence at the time of the Fed’s manipulation.”

      • LK says:

        So you are saying, yes, it did induce an ABC and there was no real “recovery” in 1921?

        Why, then, do Austrians persist in pretending that there was some “free market” recovery in 1921 free of government intervention?

        Your narrative should be: “the dirty government just induced another Austrian business cycle in 1921-1922 and an unsustainable boom”.

        • guest says:

          No, what I’m saying is that a free-er market (than during the Great Depression) was correcting malinvestments and creating a more sustainable capital structure just fine before the Fed decided to inflate another unsustainable boom.

        • Major.Freedom says:

          But according to Austrian criteria of tightening versus loosening, the Fed tightened.

          This is not the same thing as the free market existed.

          It was closer to the free market.

          If an actual free market was allowed to function, the recovery would have been even swifter and even less painful.

    • skylien says:

      “It is absurd to think that wages today could exhibit that degree of flexibility.”

      I am still wondering how it is possible that I had to suffer a nominal 5% wage cut in 2009… (The wage cuts in our company went up to 25% depending on your position!) Yet LK tells me that is impossible.

      • Scott D says:

        Didn’t happen. You must be remembering incorrectly. Human behavior has to fit the models.

      • Dan says:

        The company of this girl I was dating in 2009 had a bunch of people laid off, and the people remaining saw their pay reduced by 20%.

        • Bob Murphy says:

          Dan, in fairness LK can say “The Bunny Ranch” is an anomalous company.

          • Bob Roddis says:

            Keep it polite, Murphy. I always do.

          • Dan says:


          • LK says:

            You presumably know perfectly well that when I refer to wage stickiness I am referring to a **general** phenomena as seen in the economy as whole that is clearly of great economic significance, and especially in the aggregate data. Nobody ever doubts that a minority of companies and people do experience some nominal wage cuts.

            • Bob Roddis says:

              Excuse excuses. All empirical claims should be based upon detailed knowledge about each and every specific set of individual actors. Your “aggregate” analysis nonsense is just an excuse to deflect the fact that you do not and cannot have the necessary detailed evidence you require.

              • LK says:

                Since aggregate data is based on the individual data, and couldn’t exist without it, we can only conclude your rant is of no interest to serious discussion of this subject.

              • guest says:

                The aggregated data from individuals isn’t helpful to you without understanding what the individuals’ contributing data points mean.

                And since economic data is based on subjective preferences, you would have to know all of each individuals’ preference scales for each separate transaction, in order to know what the aggregate data meant.

                Preference scales are subjective, so no one has access to them but the individual; And the scales change constantly.

                This is why aggregate economic data means nothing, in spite of the ability to do math on the numbers.

              • Major.Freedom says:


                Do you know what “generally” really means when you say it? That you refuse to accept empirical data that conflicts with your “sticky wages” mantra.

                No individual employer or employee cares about aggregate wages. They care about specific wages, at specific times, at specific places, producing specific things.

                Just because your neighbor’s wages did not fall, and yours did, it does not entitle you to say wages are “generally” sticky. There is no single mind controlling all wages such that this mind selects wages to be “generally” sticky. If some wages are sticky while other wages are not, then clearly that disproves any claim about wages as such being generally anything.

                There are two distinct events going on, your wages going down and your neighbor’s wages going up.

                If demand goes down, what that means is that demand in specific goods goes down, without any other good’s demand going up enough to make total demand remain flat or rising.

                There is no justification for government intervention that affects everyone, because of some specific event in specific goods industries where wage rates did not fall with a fall in demand.

                Your aggregations are muddleheaded meanderings designed specifically to divert attention away from empirical, detailed facts consisting of wage rate declines. You want us to ignore them minimize them, pretend they are not “really” empirical events.

    • Bob Roddis says:

      Excuses excuses. Wages and prices always adjust quickly when people would go hungry otherwise.

      Further, there is nothing “anomalous” about this episode. Both 1920 and 1929 were caused mostly by hangovers of central bank monetary shenanigans beginning in WWI.

      The problems were (as always) caused by violent government intervention and which were (as always) cured by market forces.

      Finally, you are still unable (as always) to differentiate the historical voluntary transactions from the violent interventions upon which your anecdotal analysis depends in order to blame “the free market” for these problems.

      • LK says:

        “Wages and prices always adjust quickly when people would go hungry otherwise. “

        Even that is unlikely. If businesses see no reason to expand production or unemployment through lack of demand, even workers offering lower wages isn’t going to necessarily make business produce more if they don’t think anyone will buy the output.

        • Major.Freedom says:

          It is not unlikely at all. People “likely” want to stay alive and will find a way to do so even in a world where property rights are strongly respected.

          And your theory of demand as the cause is backwards, again.

          There is no such thing as “lack of demand”. Demand is demand is demand. Whatever that demand is, costs can fall below that demand.

          Nobody buyig any output? What planet are you talking about? At no time in human history has demand for goods collapsed to zero.

          ANY positive demand is capable of making any quantity of labor employable, provided wages are free to fall, i.e. without government or any other violent meddling.

          When wages are free to fall, they will tend to fall below demand, because of the time preference of those paying wages.

          You are talking about a make believe world of unicorns and faeries, where there is no demand for any goods.

          In the real world, where demand is positive, then cost prices can be as low as they need to be to make investing in those costs worthwhile. Wage rates in a profit seeking, private property society, tend to fall MORE than any fall in output prices, because of the demand from those paying wages putting an opposite pressure on those prices, as they have to eat and enjoy life as well. So the combined money spending from workers and those who pay for labor, will result in a nominal demand for goods that exceeds wages.

    • Enopoletus Harding says:

      1. It wasn’t Fedfunds yet, it was discount rate.
      2. The NYFed discount rate was higher at the end of the NBER recession than it was at the beginning. Also, most short-term interest rates were more market-determined than Fed-determined then.
      3. The monetary base consistently lagged the industrial production index:

      It is absurd to think that wages today could exhibit that degree of flexibility.


    • Major.Freedom says:

      “Yes, but the trouble is that the 1916-1923 period stands out as being highly anomalous in American history for wage movements”

      So does a relatively modest government response to deflationary periods caused by prior government inflation!


      Are you really unable to separate theory from history? History is full of government meddling, and rare are times of “austerity” after governments mess up the economy. After all, if the government is the cause for economic messes being created, then chances are they will try to “fix” the mess as well!

      You need to improve your theory.

  3. Bob Roddis says:

    Daniel Kuehn’s paper proved beyond a shadow of a doubt that the 1920 crisis was caused a sharp change in direction of government intervention after WWI. You get get a link to a free version of the paper here:


    I’m still waiting for proof that these problems were caused by “the free market”.

    • LK says:

      So government policy helped to cause the recession and Fed policy helped to cure it? lol

      • Major.Freedom says:

        No, because the “cure” then caused the collapse in 1929.

        A real cure would not cause the very thing the cure was designed to fix.

      • Bob Roddis says:

        Are any Keynesians even trying to argue that inflationary Fed policy facilitated or caused the very large price and wage restructuring that came about in 1920-1921?

        Lesson to be learned: The market did not fail, but the market quickly reset unsustainable government-induced wages and prices.

        Keynesianism has been eviscerated.

  4. Bob Roddis says:

    No matter how many times Tom Woods mentions Wilson’s “Stoke of Luck”, the Austrians do not even know that Wilson’s spending cuts occurred prior to Harding taking office, thereby refuting the Austrian School once and for all:


    • guest says:

      “… the Austrians do not even know that Wilson’s spending cuts occurred prior to Harding taking office, thereby refuting the Austrian School once and for all …”

      Spending cuts on malinvestments results in a correction, consistent with ABCT. Remember that ABCT says that the “downturn” is the cure.

      The recovery then happened without much FED intervention.

  5. Lee Waaks says:

    As I recall, George Selgin and Daniel Kuehn had a brief exchange about 1920-21. I think Selgin summed up Kuehn’s position as ‘there was no aggregate demand failure because there was no aggregate demand failure.’

  6. Andrew_FL says:

    Personally, I wouldn’t date the unsustainable Boom until after 1923, since the Private portion of GDP was still below it’s long term trend until then, by my estimations. In fact, it was below trend consistently since 1917. This is fairly typical of war time expansions of Government, the private sector is displaced.

    Nevertheless, LK seems to be a bit confused. Not *every list drop* of economic growth during the 1920s was unsustainable boom. A portion of it was. Therefore the Fed created an unsustainable boom *on top of* a real recovery. Not *instead of* a real recovery.

  7. Bob Roddis says:

    More proof that we keep repeating the same stuff over and over which then gets ignored or distorted……

    Bob Murphy 1/24/12: I have all sorts of sarcastic wise-alecky things I could say, but let me just play the straight man on this one. On Sunday Krugman had a quick post titled “Harding” in which he alluded to unnamed gnats who kept repeating that the 1920-1921 experience showed the success of austerity policies. Krugman at that time referred to his earlier post on the subject, and then said:

    And let me be peevish: if you’re reading this blog, before demanding that I respond to some argument or other, why not use the little search box off to the right? Not always, but often, I’ve already done what you demand.
    (Keep that in mind; it will prove humorous in a bit.)

    Then I imagine what happened is that someone (perhaps Daniel Kuehn himself) either in the comments or over email, informed Krugman that Kuehn had recently published a note in the Cambridge Journal on just this issue. So in a follow-up post on Monday, titled “More Than You Want to Know About Warren Harding,” Krugman wrote:
    Yesterday I mentioned that they’re still flogging the old line that Warren Harding proved that austerity works. I linked to my old demonstration that the 1921 economy was nowhere near the liquidity trap, and that there was substantial monetary easing, making comparisons to the current situation nonsense.

    Daniel Kuehn has more. it turns out that the Austrians/Austerians have their timing all wrong:

    [From Kuehn’s paper:] Austerity proponents depend on the argument that substantial cuts to federal spending moved the economy to a recovery in 1921, but this understanding fails on multiple counts. The bulk of both fiscal and monetary austerity occurred immediately prior to the onset of the depression. Any austerity in policy decisions by the Wilson administration, the Harding administration or the Federal Reserve Board after the depression began were moderate compared with the considerable austerity measures taken by the Wilson administration and the Federal Reserve before the downturn. The evidence seems to suggest, even more clearly than in the case of the Great Depression, that postwar austerity may have even helped cause the 1920–21 depression. Subsequent monetary easing by the Federal Reserve occurred concurrently with the economic recovery, which itself was underway by the time Warren Harding took the oath of office.

    And here’s a chart:

    I am quite sure, however, that none of this will stop the Harding thing from being rolled out again repeatedly.
    So naturally I clicked on the link to Daniel’s paper, where I read this: “Contrary to the claims of Woods (2009) and Murphy (2009), most of the austerity measures were implemented by the Wilson administration before industrial production peaked in January 1920.”


    Query: What is the alleged significance of the “austerity” coming during Wilson’s term rather than Harding’s (not that anyone actually made that mistake)? Sounds like just another diversionary tactic to me.

    • Andrew_FL says:

      If they push back the date of the austerity, they can claim in caused the recession, and therefore can’t be credited for the recovery. Or so they imagine, I suppose.

      And then they can tell themselves a story about how easy money saved us from an austerity driven depression.

    • Andrew_FL says:

      It’s also good partisan point scoring. “Ha, but the credit should go to Wilson, who was of my Party, not Harding, who was of yours!”

      • Bob Roddis says:

        But the “austerity” did cause the crisis which was not a market failure while the market was able to quickly readjust.

        Further, Tom Woods often refers to ‘The Stroke of Luck” (which he admits is in bad taste). Wilson had a stroke near the end of his term and was not up to slowing down the slashing of government spending. I’ve never understood where the myth arose that Woods and Murphy were unaware that spending was slashed under Wilson. Tom mentioned Wilson’s stroke (and his inability to halt the slash in spending) way back in 2009 in this video:


        • Andrew_FL says:

          I’m not convinced that the slashing of wartime spending caused the private economy to briefly falter. It certainly didn’t go down that way in 1946. At that time, the drop in government spending after the war was accompanied by large increases in private investment (of which, there had been almost none during the war), in other words the government contracted without the private sector also contracting at the same time or afterward-indeed with it *expanding*. In contrast, there was a relatively small contraction of the private sector between 1920-21.

          Don’t get me wrong I don’t think “the market failed” in 1920. For one thing before then there was significant intervention in the economy. But I don’t think Government spending cuts contributed much to the brief crisis itself, either. It was probably more related to the prior Fed induced inflation, as Austrian Business Cycle Theory would predict.

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