The “Depression” of 1920–1921: The Libertarian Myth that Won’t Die

Yes, there was a recession from 1920–1921, but its history and significance are badly misrepresented by libertarians and Austrian economists, and the following talk by James Grant is a case in point. Grant even has a forthcoming book on the recession called The Forgotten Depression: 1921: The Crash That Cured Itself (2014).



What are the problems here?

They are as follows:

(1) the downturn of 1920–1921 was not a depression, if “depression” is defined as a contraction in the business cycle where real output fell by 10% or more.

The two best estimates of the depth of the downturn of 1920–1921 are Romer (1989) and Balke and Gordon (1989: 84–85).

Romer (1989) provided a new estimate for GNP declines from 1920 to 1921, as follows:

Year | GNP* | Growth Rate
1914 | $414.599
1915 | $443.048 | 6.86%
1916 | $476.498 | 7.54%
1917 | $473.896 | -0.54%
1918 | $498.458 | 5.18%
1919 | $503.873 | 1.08%
1920 | $498.132 | -1.13%
1921 | $486.377 | -2.35%
1922 | $514.949 | 5.87%
1923 | $583.105 | 13.23%
* Billions of 1982 dollars
(Romer 1989: 23).

These estimates show a GNP contraction of only 3.47% from 1919 to 1921, a mild to moderate recession.

By contrast, Balke and Gordon (1989: 84–85) estimate a GNP decline of 5.58% from 1920–1921, a moderately bad recession.

On either of these estimates, however, the downturn of 1920 to 1921 was nothing like the Great Depression, and, as we will see below, was an anomaly in other ways.

(2) Even the idea that the recession of 1920 to 1921 was some remarkably short recession is untrue. The recession lasted from January 1920 to July 1921: a period of 18 months. But a recession lasting 18 months is in fact quite a long one by the standards of the post-1945 US business cycle. The average duration of US recessions in the post-1945 era of classic Keynesian demand management (1945–1980) and the neoliberal era (1980–2010) has been about 11 months (Carbaugh 2010: 248; Knoop 2010: 13). So far from being some remarkably quick recession that was shorter than post-1945 recessions, it was about 7 months longer than the post-1945 average.

(3) At 12.29–12.33, Grant says that the recession of 1920 to 1921 was “the last governmentally unmediated major business cycle downturn.” This is untrue. Why? Because the Federal Reserve existed, and engaged in both open market operations and interest rate reductions as a deliberate strategy to stimulate recovery. In particular, by April and May 1921, the Federal Reserve member banks dropped their rates to 6.5% or 6%. In November 1921, there were further falls in discount rates: rates fell to 4.5% in the Boston, Philadelphia, New York, and to 5% or 5.5% in other reserve banks (D’Arista 1994: 62).

From the perspective of libertarian ideologues, it was worse than this, because other government interventions occurred as follows:

(1) a proto-form of quantitative easing by the Federal Reserve 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).

(2) direct credit allocation by the government “War Finance Corporation” and the “Federal Land Bank system” from early 1921, in which loans were granted to distressed farm cooperatives and other agricultural businesses. In August 1921, the War Finance Corporation corporation even became a rediscount agency for agricultural and livestock producers.

(3) there was even some limited deficit-financed public works, in the form of municipal bonds.

What should be particularly embarrassing for libertarians and Austrians is that all these interventions were known to and described by Rothbard (see Rothbard 2000: 137–138, 191–193).

(4) Running through the talk is the bizarre background assumption that Keynesian economics says that economies can never recovery from recessions without government intervention. But that is not what Keynes or Keynesians think. What Keynes thought was that there is no universal, consistent, and reliable tendency for market economies to converge to full employment equilibrium. This does not mean that market economies can sometimes recover relatively rapidly from recessions, under the right circumstances.

(5) There were a number of reasons why the recession of 1920–1921 was unusual and indeed anomalous, and why it did not become very severe and protracted:

(1) the deflation was caused to some great extent, not by demand shocks, but a positive supply shocks in commodities due to the resumption of shipping and production after WWI (Romer 1988: 110; Vernon 1991).

(2) the recession of 1920–1921 also had no serious financial crisis, and no mass bank runs and collapses;

(3) the level of private debt was considerably lower in 1920 than in 1929, and the real value of debt had been reduced considerably by the large WWI and 1919 inflation, so that debt deflationary forces did not become severe.

In short, 1920 to 1921 was an anomalous recession, it was not especially short, it did have monetary interventions that aided recovery, and it is absurd to think that you can make sweeping generalisations from it about how government interventions are never needed to stabilise economies.

Further Reading
“The US Recession of 1920–1921: Some Austrian Myths,” October 23, 2010.

“There was no US Recovery in 1921 under Austrian Trade Cycle Theory!,” June 25, 2011.

“The Depression of 1920–1921: An Austrian Myth,” December 9, 2011.

“A Video on the US Recession of 1920-1921: Debunking the Libertarian Narrative,” February 5, 2012.

“More Fake History of the Great Depression,” September 28, 2012.

“The Recovery from the US Recession of 1920–1921 and Open Market Operations,” October 4, 2012.

“Rothbard on the Recession of 1920–1921,” October 6, 2012.

“The Recession of 1920–1921 versus the Depression of 1929–1933,” February 2, 2014.

“Debt Deflation: 1920–1921 versus 1929–1933,” February 3, 2014.

“US Wages in 1920–1921,” February 10, 2014.

“The Causes of the Recession of 1920–1921,” February 11, 2014.

BIBLIOGRAPHY
Balke, N. S., and R. J. Gordon, 1989. “The Estimation of Prewar Gross National Product: Methodology and New Evidence,” Journal of Political Economy 97.1: 38–92.

Carbaugh, R. J. 2010. Contemporary Economics: An Application Approach. M.E. Sharpe, Armonk, New York.

D’Arista, J. W. 1994. The Evolution of U.S. Finance, Volume 1: Federal Reserve Monetary Policy: 1915–1935. M. E. Sharpe, Armonk, New York.

Grant, James. 2014. The Forgotten Depression: 1921: The Crash That Cured Itself. Simon & Schuster.

Knoop, T. A. 2010. Recessions and Depressions: Understanding Business Cycles (2nd edn). Praeger, Santa Barbara, Calif.

O’Brien, Anthony Patrick. 1997. “Depression of 1920–1921,” in D. Glasner and T. F. Cooley (eds), Business Cycles and Depressions: An Encyclopedia. Garland Pub., New York. 151–154.

Rothbard, Murray N. 2000. America’s Great Depression (5th edn.). Ludwig von Mises Institute, Auburn, Alabama.

Romer, C. D. 1988. “World War I and the Postwar Depression: A Reinterpretation based on Alternative Estimates of GNP,” Journal of Monetary Economics 22.1: 91–115.

Romer, C. D. 1989. “The Prewar Business Cycle Reconsidered: New Estimates of Gross National Product, 1869–1908,” Journal of Political Economy 97.1: 1–37.

Vernon, J. R. 1991. “The 1920–21 Deflation: The Role of Aggregate Supply,” Economic Inquiry 29: 572–580.